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November 20, 2010
The Progressive Cure Will Kill You
While a case could have been made for Ben Bernanke's Fed plan to print money to buy government debt, is the timing of this plan good monetary policy or just bad politics?
First of all this scheme confirms the fault inherent in the Obama, Krugman, Keynesian stimulus theory. The federal government doesn't have the ability to print money so when it embarks on a spending binge, like the stimulus, it has to get it somewhere. So it sells government bonds.
Now, much has been made by pundits that the Chinese are financing our government debt. But the Chinese aren't even the largest foreign buyer anymore. The Japanese are. In fact the Chinese were actually net sellers of U.S. debt in December of last year. They only represent about 10% of all debt purchases. By a large margin the U.S. debt is held by U.S. investors, companies, pension funds and local government units. We owe the debt to ourselves.
So when the government is in the market competing for capital it in effect crowds out private investment - private investment that would stay at home. Would you rather buy a corporate bond, with it's inherent risk, or buy a Treasury bond with, supposedly, guaranteed security, and some indexed for inflation. And, with tax increases looming, even tax free bonds?
Consider also the chilling effect on corporate bonds that the government takeover of GM produced with it's heavy handed treatment of the bond holders by giving 20% of their equity to the UAW. This move has now created a risk premium in corporate debt markets that did not exist before. Why compete with the government when you can join it?
So what good is a stimulus if, in the process of borrowing the money to spend, the government crowds out private investment, which is the real engine of wealth creation?
Enter the Fed. Unlike the government, the Federal Reserve can print money. And then they can buy that government debt which in effect funnels the money directly to the government. In doing this, in theory, there is no competition for private capital, interest rates would possibly drop, and the stimulus would therefore all go into the economy.
But there is no free lunch. This process monetizes the government debt. It is inherently inflationary. And it is playing with fire.
Problem is Ben Bernanke's preoccupation, as pointed out in a great article by Michael Barone in Townhall.com, is deflation. He has written extensively about his fear of it. But what Bernanke misses is what Milton Freidman was so good at pointing out. Inflation (or deflation) is a monetary phenomenon. It is reflected in prices in general, not in particular.
We have already experienced a major deflationary event. The crash of the housing market. A lot of our wealth was in our homes and it disappeared when the market crashed. We feel poorer as a nation because of this event. And yet, are we? Most of the equity we lost was on paper. It is like that stock that shoots sky high one day and then crashes the next. You were rich one day and poor the next but never actually had the money and most importantly it was wealth you never had the burden of creating. We may feel this loss of equity someday, particularly when all the boomers want to retire, but it's effect is not that great today.
So we had deflation in one market, the housing market. It's a major market but it is still just one market, and does not create or reflect a monetary phenomenon. It is pricing in particular and not in general. And yet Bernanke, after that event has occurred, want's to inflate not just housing prices but all prices.
Seen the price of oil lately? How about gold, silver, aluminum and even steel? All of these materials have been gaining in price in the last year. What is the common denominator? They are all priced in dollars. These are commodity price increases in general, not particular and they reflect inflation not deflation.
So why monetize the debt now? Even though some pain still exists, the big deflationary event is long over. Excluding foreclosures, which have little or nothing to do with house prices (unemployment is the single biggest factor in housing defaults, even when mortgages are upside down), housing prices have stabilized and even begun rising outside the hardest hit areas.
We have year over year commodity price inflation, energy costs have been increasing and will go higher when the EPA does it's bureaucratic best to raise them, food prices are increasing and taxes are slated to rise. To seek to create inflation at this point in the recovery after we have largely handled the main crises is not policy driven, it is politics.
We have already survived the pain of the housing bubble. Why do we now need to suffer the progressive cure? Or is this just another crisis in the making too good to waste?