Hello Stagflation!

[Big Phil]

What I'm hearing from Ossus is that there are no limits (legal or practical) on the rate at which the Fed can add or remove liquidity from the economy, and that if you can just keep the money supply on track the economy will always be just fine, regardless of other factors. Both of which I find hard to believe. I guess it depends on your definition of "just fine." Am I understanding you correctly, sir?

I don't see MoO saying the economy will be "just fine." I see him explaining basic economic theory to a number of people who don't seem to grasp it, but I haven't seen any claims made that the economy is "just fine."

[J]

So what are the root causes of the current mess?

1. Implosion of the housing bubble, starting with the subprime sector and spreading into the rest of the market. This has wiped out a large source of consumer spending as many people rely on the equity in their homes to fuel their spending. People are also defaulting and walking away from their homes after ending up with negative equity, which is bad news for the financial institutions which use their mortgages as the base of their highly leveraged and questionable investment schemes. This is also costing towns & cities a lot in tax revenues as property values continue to fall.

But it has a direct effect on prices, which drop as a result of all of this. This will tend to counter inflation.

So why has inflation risen in recent months after the first wave of subprime homes started defaulting and the various financial institutions taken their first round of losses?

I don't even understand how destroying liquidity in the banking system is possible in the way that you describe. The whole point of the Federal Reserve is that it can create or destroy liquidity in the financial markets at will.

Gee, maybe you should read this then, after which you can read the full 40-odd page report.

Excerpt:

NEW YORK (MarketWatch) - The economic impact of the mortgage crisis and credit crunch will be huge, and it has barely begun, a new study prepared by several prominent economists and released Friday has concluded.

"Feedback from the financial market turmoil to the real economy could be substantial," it said. Unless they can quickly recapitalize, banks are likely to cut back their lending to consumers and businesses by more than $1 trillion, cutting economic growth by more than a percentage point over the next 12 months.

The report was released at a forum on U.S. monetary policy in New York in which several senior Federal Reserve officials and economists were participating. Read the full study.

That's how it happens.

I don't understand what you mean by an auction market "locking up." Moreover, small businesses and governments go insolvent all the time. Why is this creating a particularly large jump in unemployment, and why in the world would it lead to inflation?

The bonds aren't selling, and the interest rates on the bonds have reset all the way up to the 20%-30% upper limits costing the bonds issuers huge amounts of money. In case you've missed it, many existing bonds are now being re-evaluated and downgraded and this is costing financial institutions almost as much as the subprime clusterfuck, and combined with that mess it's causing them to tighten up their lending or face insolvency, or both. Not only are municipalities & other bonds issuers going insolvent which by itself costs jobs, it's forcing banks to scale back on their own investments which also puts a nice crimp in wealth & job creation.

First of all, Bernanke also mentioned repeatedly that he's more concerned now with inflation than with unemployment, which is something that Greenspan essentially never said. Second of all, this is precisely one of the unemployment-fighting measures that you poo-poohed in the opening post.

What he says is in no way consistent with what he does. Helicopter Ben's opinions on the state of the economy are about as truthful as Dan Yergin's predictions of oil prices, which is to say if I believed him I'd be broke.

By the way, mortgage rates are closely tied to the yield of Federal bonds. By tanking the short term lending rates the yield of long-term bonds is driven upwards, and where they go, mortgage rates follow. Which leads to yet more mortgage defaults, more people out of money, more pain for the financial sector and higher unemployment.

So with a large amount of debt, consumers can spend to stimulate the economy, but with even a slightly higher level of debt they can't do that, anymore?

It's not just the large amount of debt, consumers are now out of ways to get into even more debt to finance their spending. They've tapped out their credit, their cars, their homes, and many are now raiding their retirement plans. There are no futher sources of money for spending especially now that banks are tightening up their credit requirements after their financial woes. People are actually being denied credit cards and lines of credit, imagine that. The money well has dried up.

[Zablorg]

A couple of questions about J's list:

Are the people simply running out of money to buy things like cars and such, or are they facing more of a "I can't feed my family" sort of thing?

Your list suggests that the economy could be solved with enough time and more importantly, the right people running the show. What do you think about this?

[J]

Are the people simply running out of money to buy things like cars and such, or are they facing more of a "I can't feed my family" sort of thing?

Right now it's the former for most people, with those who are less fortunate suffering the latter.

Your list suggests that the economy could be solved with enough time and more importantly, the right people running the show. What do you think about this?

I think it can be solved, but it's going to be neither quick nor painless. All the garbage has to be aired and worked out of the system, and one way or another it will happen. Whether it happens voluntarily, through government regulations & beatings, or an outright collapse as liquidity & capital vanishes or whatever combination of the above we don't know, but it will happen.


Back to something I forgot to add in my earlier posts. If banks aren't hurting for liquidity, then why did Citigroup have to borrow $7.5 billion from the Arabs at 11% rates, instead of say, borrowing money from the other US banks at the preferred rate which is around 7%? Also, why are the non-borrowed reserves of US financial institutions over $17 billion in the hole? If the rate cuts are creating liquidity as claimed, then why aren't US banks lending to each other, why are many of them going overseas to borrow money and raise capital and paying exhorbitant rates to do so?

[Setesh]

A couple of questions about J's list:

Are the people simply running out of money to buy things like cars and such, or are they facing more of a "I can't feed my family" sort of thing?

I don't know about everywhere but many are in the same boat I am with a 'pay what you can when you can' situation on even important bills. I for instance am forced to skip paying my heating bill every other month because I simply don't have the money to pay them now. This is causing a 'backlog' of debt to the Gas company (which here at least was no longer cheaper than oil or electric heat this year having started winter making everyone who'd ever missed a bill pay a 'security deposit' of $450 or face no heat) to build up I'll be paying off the entire summer.

Your list suggests that the economy could be solved with enough time and more importantly, the right people running the show. What do you think about this?

Our economic woes are solvable, but we're not going to take the measures necessary to do so. The best option (in my opinion anyway) is to pass federal legislation to 'fix' the cost of basic necessities (Water, heat, power, basic foodstuffs) to a level a minimum wage job can afford with at least some money to spare. Even if its not often that money is now spent on other things stimulating the economy. Next Iraq, leave, cold turkey. We've wasted trillions already, lets grind this to a halt. The fuckers hate us already there is no win here regardless without exterminating 50% of the populous and replacing them with someone more friendly to us.

Speaking of our absurd national debt, except for the terminally blind everyone should have noticed by now that when our debt was at it's lowest (under Clinton) the economy was at its highest. Now the federal debt is huge and we're all fucking broke, hope the economists learn something from this (something that strangely everyone else seemed to know, Debt is BAD), but I doubt it.

The Debt as of 02 Mar 2008 11:06 EST is $9,346,884,496,533.81 , that means each of the 304,505,921(est.) US citizen would have to pay $30,695.25 to clear this debt, that's more than I make in a year.

[Zablorg]

Obama said he never liked the idea of the Iraq war in the first place. Can we expect any changes in that respect once he's in presidency?

[Mr Bean]

Obama said he never liked the idea of the Iraq war in the first place. Can we expect any changes in that respect once he's in presidency?

Zablorg in my position as a Moderator I have to ask, do you have the slightest fucking clue what this thread is about?

Trust me, it's NOT about the Iraq war(Even if that is having an economic impact as it can be tied to the falling dollar)

Right back to the thread already in progress

[Master of Ossus]

I didn't mean to imply that banks are not lending at all, that's silly. The Fed has stated that it's disappointed by the response to the last two interest rate drops, and I'm left wondering why dropping the rate further at this point would be any more effective. I was proposing a hypothetical mechanism by which the extent that banks are "tightening the purse strings" is exceeding the extent that the Fed is loosening theirs, which is the only reason I can see for the Fed to be disappointed by the effects of their rate cut. I can't seem to locate the article on businesses that are suddenly having trouble getting loans, whether in an absolute sense or because the cost of borrowing has increased. I'll have to get back to you on that.

Fair enough. Even if the Fed is disappointed, though, by the magnitude of their intervention, that does not imply that further cuts will not have some impact. Really, that's all that is required here to show that this will tend to counter job cuts.

What I'm hearing from Ossus is that there are no limits (legal or practical) on the rate at which the Fed can add or remove liquidity from the economy, and that if you can just keep the money supply on track the economy will always be just fine, regardless of other factors. Both of which I find hard to believe. I guess it depends on your definition of "just fine." Am I understanding you correctly, sir?

Two things:
1. There are no practical limits as to how quickly the Fed can add or remove liquidity. I concede that there are small time gaps from the time when the Fed begins implementing a new policy to the time where the various markets that they rely on clear, but this lag can be measured in a period of hours or days as financial institutions adjust themselves to the newly-announced policies and buy or sell assets in response to the Fed's moves. This is not usually a time frame that is significant to a national market. Again, the definition of a federal reserve is an institution that can create or destroy liquidity at will. This is unchecked by anything except political concerns.

2. I'm not saying that everything is hunkey-dorie--J has identified a number of legitimate problems in the economy right now. However, stagflation is a very serious but also reasonably specific type of problem in the economy, and it's not one that is supported or promoted by everything in the list that J provided.

[Darth Wong]

I am curious about this idea of "creating liquidity at will". The Federal Reserve may be able to create liquidity in the general sense, but I don't see why that means that any particular bank will necessary find its liquidity problems erased when the Federal Reserve changes interest rates or dumps money on the market.

Let's say that I'm the CEO of the Amalgamated Fuckup Bank of Springfield. Here at Amalgamated Fuckup Bank, we created superior growth for our investor by pouring vast amounts of money into high-risk commercial assets which later turned out to be worthless. As a result, we have lost billions of dollars, our balance sheet is red all over, and there is blood in the streets, to use one of Warren Buffett's phrases. Investors are calling for blood, the stock price is in the toilet, people are withdrawing funds to move them to healthier financial institutions, and it's looking really bad for Amalgamated Fuckup Bank. Then I hear on the news that the Federal Reserve has changed its interest rates; precisely how does this solve Amalgamated Fuckup Bank's problems?

[Master of Ossus]

So why has inflation risen in recent months after the first wave of subprime homes started defaulting and the various financial institutions taken their first round of losses?

Ummm... obviously because the prices of other goods and services commonly consumed by Americans has risen faster than the price of housing has fallen. There's a big lag between falling housing prices and when people actually start spending less on housing, as a whole, because people move only infrequently. For instance, the food and beverages index was up nearly a full point for January.

Gee, maybe you should read this then, after which you can read the full 40-odd page report.

Excerpt:

NEW YORK (MarketWatch) - The economic impact of the mortgage crisis and credit crunch will be huge, and it has barely begun, a new study prepared by several prominent economists and released Friday has concluded.

"Feedback from the financial market turmoil to the real economy could be substantial," it said. Unless they can quickly recapitalize, banks are likely to cut back their lending to consumers and businesses by more than $1 trillion, cutting economic growth by more than a percentage point over the next 12 months.

The report was released at a forum on U.S. monetary policy in New York in which several senior Federal Reserve officials and economists were participating. Read the full study.

That's how it happens.

Having read the article and the report, I saw nothing that I would characterize as being a destruction of liquidity in the capital market and I saw absolutely nothing that even resembled a statement that the Federal Reserve had lost the ability to create liquidity.

The bonds aren't selling, and the interest rates on the bonds have reset all the way up to the 20%-30% upper limits costing the bonds issuers huge amounts of money. In case you've missed it, many existing bonds are now being re-evaluated and downgraded and this is costing financial institutions almost as much as the subprime clusterfuck, and combined with that mess it's causing them to tighten up their lending or face insolvency, or both. Not only are municipalities & other bonds issuers going insolvent which by itself costs jobs, it's forcing banks to scale back on their own investments which also puts a nice crimp in wealth & job creation.

Bonds aren't expected to sell when the the Federal Reserve is creating liquidity. The Federal Reserve creates liquidity largely by buying bonds on the open market. Do you have a link or an article that explains this directly? I suspect that you are describing some other effect.

What he says is in no way consistent with what he does. Helicopter Ben's opinions on the state of the economy are about as truthful as Dan Yergin's predictions of oil prices, which is to say if I believed him I'd be broke.

Do you have any evidence beyond speculation that he's not concerned about inflation and will do nothing about it?

By the way, mortgage rates are closely tied to the yield of Federal bonds. By tanking the short term lending rates the yield of long-term bonds is driven upwards, and where they go, mortgage rates follow. Which leads to yet more mortgage defaults, more people out of money, more pain for the financial sector and higher unemployment.

It's true that mortgage rates are tied to the yield of Federal bonds, because these are competing investments that people can make. You have this ass-backwards, though, as to how short-term rates affect bonds. Lowering interest rates increases the value of long-term bonds that have rates locked in before the interest rate was reduced (since they are enjoying the higher interest rate, still). However, it does nothing to increase the mortgage rates. In fact, it decreases them.

It's not just the large amount of debt, consumers are now out of ways to get into even more debt to finance their spending. They've tapped out their credit, their cars, their homes, and many are now raiding their retirement plans. There are no futher sources of money for spending especially now that banks are tightening up their credit requirements after their financial woes. People are actually being denied credit cards and lines of credit, imagine that. The money well has dried up.

So how does reducing the amount of consumer spending in the economy lead to inflation?

[Master of Ossus]

I am curious about this idea of "creating liquidity at will". The Federal Reserve may be able to create liquidity in the general sense, but I don't see why that means that any particular bank will necessary find its liquidity problems erased when the Federal Reserve changes interest rates or dumps money on the market.

It doesn't mean that any particular bank will find its liquidity problems erased when the Federal Reserve modifies the overall level of liquidity in the economy, but the market as a whole has to clear. If the Federal Reserve creates liquidity, then the entire market and the financial community has more liquidity; the inverse is also true.

J's link actually said something interesting that I hadn't heard, before, in that it mentioned that large banks are the ones that are credit-crunched, and smaller lending institutions are reporting fewer problems. Larger banks are actually the ones that are most influenced by Federal Reserve policies, since they're the ones with seats at the auctions and who can most easily buy or sell assets on a scale large enough to affect the entire market.

Edit: Also, a large bank will be much more likely to actually receive the discount rate, and will thus be much more able to borrow funds from the Federal Reserve on favorable terms--they are larger and tend to therefore have better credit than smaller banks.

[Sea Skimmer]

Then I hear on the news that the Federal Reserve has changed its interest rates; precisely how does this solve Amalgamated Fuckup Bank's problems?

The bank can more easily take out loans itself, so it will have money to lend to other people and thus be able to stabilize its cash inflow. Some banks however get so bad, like that one the British just nationalized, that this isn’t realistically possible.

[Alan Bolte]

Bonds aren't expected to sell when the the Federal Reserve is creating liquidity. The Federal Reserve creates liquidity largely by buying bonds on the open market.

I don't understand this bit. The bonds aren't selling... because they're being bought?

[Master of Ossus]

Bonds aren't expected to sell when the the Federal Reserve is creating liquidity. The Federal Reserve creates liquidity largely by buying bonds on the open market.

I don't understand this bit. The bonds aren't selling... because they're being bought?

Why put up a bond at a private auction house when the Federal Reserve will buy it for sure? The bonds that are left are affected by adverse-selection. People are probably holding non-government bonds, in the meantime, because they're happier with the interest rate on the assets they've already purchased, so there's little reason to sell them unless you think interest rates are going up in the near future (or going up faster than the market is predicting), but given Bernanke's comments and the state of the economy, this seems like a dubious bet to me.

[Broomstick]

So how does reducing the amount of consumer spending in the economy lead to inflation?

Could a shortage in an essential commodity cause an inflationary price rise even when consumers spend less?

For example, could rising fuel and food prices increase inflation faster than a falling housing market can reduce it?

[Big Phil]

So how does reducing the amount of consumer spending in the economy lead to inflation?

Could a shortage in an essential commodity cause an inflationary price rise even when consumers spend less?

For example, could rising fuel and food prices increase inflation faster than a falling housing market can reduce it?

Yes - he said that earlier this morning in his response to J.

Ummm... obviously because the prices of other goods and services commonly consumed by Americans has risen faster than the price of housing has fallen. There's a big lag between falling housing prices and when people actually start spending less on housing, as a whole, because people move only infrequently. For instance, the food and beverages index was up nearly a full point for January.

[Darth Wong]

What's the difference between the Federal Reserve "adjusting liquidity in the banking sector" by buying up all their no-longer-so-desirable bonds and simply bailing out the banks by giving them government-secured loans?

[J]

Having read the article and the report, I saw nothing that I would characterize as being a destruction of liquidity in the capital market and I saw absolutely nothing that even resembled a statement that the Federal Reserve had lost the ability to create liquidity.

You mean other than the part which reads

"Feedback from the financial market turmoil to the real economy could be substantial," it said. Unless they can quickly recapitalize, banks are likely to cut back their lending to consumers and businesses by more than $1 trillion, cutting economic growth by more than a percentage point over the next 12 months.

If banks aren't lending, that's a destruction of liquidity. If the money isn't moving, it's not liquid.

The bonds aren't selling, and the interest rates on the bonds have reset all the way up to the 20%-30% upper limits costing the bonds issuers huge amounts of money. In case you've missed it, many existing bonds are now being re-evaluated and downgraded and this is costing financial institutions almost as much as the subprime clusterfuck, and combined with that mess it's causing them to tighten up their lending or face insolvency, or both. Not only are municipalities & other bonds issuers going insolvent which by itself costs jobs, it's forcing banks to scale back on their own investments which also puts a nice crimp in wealth & job creation.

Bonds aren't expected to sell when the the Federal Reserve is creating liquidity. The Federal Reserve creates liquidity largely by buying bonds on the open market. Do you have a link or an article that explains this directly? I suspect that you are describing some other effect.

Bloomberg link
NY Times link

No one, not even the Federal Reserve is buying these bonds.

Do you have any evidence beyond speculation that he's not concerned about inflation and will do nothing about it?

http://news.yahoo.com/s/ap/20080227/ap_ ... e_congress

Excerpt:

The Fed is prepared to lower rates again to bolster economic growth, Bernanke said. The Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," he said, sticking closely to assurances he offered earlier this month.

If helicopter Ben is concerned about inflation, why is he so willing to lower the rates yets again?

It's true that mortgage rates are tied to the yield of Federal bonds, because these are competing investments that people can make. You have this ass-backwards, though, as to how short-term rates affect bonds. Lowering interest rates increases the value of long-term bonds that have rates locked in before the interest rate was reduced (since they are enjoying the higher interest rate, still). However, it does nothing to increase the mortgage rates. In fact, it decreases them.

Maybe you'd like to explain the 1st graph on this page, which charts mortgage rates, showing that recent interest rate cuts have resulted in higher rates. For reference, the Fed cut its rates on Oct.31, Dec. 11, Jan. 22, and Jan 30. Note what happens on the graph around those dates.

So how does reducing the amount of consumer spending in the economy lead to inflation?

I never said it did, it leads to unemployment.

[Alan Bolte]

I never said it did, it leads to unemployment.

So what does lead to the inflation part of the stagflation you proposed? Oil and other factors external to the U.S.?

Why put up a bond at a private auction house when the Federal Reserve will buy it for sure?

Thank you. I figured it was something like that, but I hate not knowing specifically. Of course, between J's links, and Valdemar's thread saying that the Fed is considering buying bonds but isn't yet, at present there must be another reason they aren't selling.

I'm also interested in an answer to Darth Wong's question, with two additional notes:
1) As far as I can tell, bailing out the banks when it is deemed necessary is a main purpose of the Fed, or any central bank.
2) Buying paper the banks don't want is different from a low-interest loan in that it's "real" money, not debt they have to make payments on, and in that it moves the cost of the falling value of these assets from the banks to the public sector. You might as well gift wheelbarrows full of benjamins to the banks.
Is the above correct?