Jenny Strasburg captures the mood on Wall Street in her article in the Wall Street Journal this morning: http://online.wsj.com/article/SB20001424052748704515704575282982462922628.html#mod=todays_us_money_and_investing.
“The competition is on to scoop up Wall Street traders and portfolio managers increasingly unnerved by the likelihood of sweeping new financial regulation.
Since political momentum began building earlier this year to limit trading for profit at Wall Street firms, traders have been exploring their options, and some have already left. Outside the banks, private investment funds looking for traders have been gearing up for a hot talent market.”
Economics works!
You change the incentives and people change…people move.
With the situation being more mobile than ever, with the technology more available and adaptable than ever, with the future more uncertain than ever…people…and the system…can change more rapidly and in more different directions than ever before.
And, that is what is happening!
This is one thing that Congress (and others) can’t seem to understand. Even after observing fifty years of the most dramatic financial innovation that has ever taken place in the world, the members of Congress seem to believe that they can “freeze” things, return to the past, and prevent the recent financial crisis from ever occurring again.
They also seem to think that the government is blameless from creating any incentives that might have a derogatory impact on the future that they want to create.
People in the Obama administration, as well as members of Congress, seem oblivious to the fact that over the last fifty years the United States government, Republicans and Democrats alike, produced a fiscal environment that created the incentives that led to a burst of innovative activity in the financial sector that produced massive changes in the way people did business and in the composition of the American economy. A brief picture of the environment.
From January 1961 through January 2009, the Gross Federal Debt of the United States rose at a compound annual rate of 7.7%. The monetized portion of the federal debt, the monetary base, rose at a compound rate of about 6.5% from January 1961 through August 2008, just before the Federal Reserve’s balance sheet exploded in response to the financial crisis that took place in the fall of 2008. The M2 money stock grew by more than a compound rate of 7.0% during the time period under review.
Thus, money and credit variables grew relatively in line with one another. Real GDP growth during this time was about a 3.4% compound rate of increase every year.
Prices, as measured by the Consumer Price Index and the GDP implicit price deflator, increased at a compound rate of about 4% during this time period resulting in a decline in the purchasing power of the dollar by around 85%. A 1961 dollar bill could only buy 15 cents worth of goods in 2008!
Inflation breeds financial innovation and the late 20th century with its relatively moderate, yet steady increase in prices, was a perfect environment for financial innovation!
The leader in financial innovation was the federal government itself, confirming what Niall Ferguson argues in his wonderful book, “The Ascent of Money: A Financial History of the World.” Ferguson claims that governments, historically, have been the primary financial innovator because of the need to fight wars. This, he continues, spilled over into the 20th century as governments needed to expand deficit financing to incorporate spending on social programs.
My guess is that in the next five to ten years we will see the biggest change in finance that we have ever seen and this change will be worldwide. I have written a little on this in a recent blog: “Changes Continue to Shakeup the Banking System”. See http://seekingalpha.com/article/200475-changes-continue-to-shake-up-the-banking-system.
The largest twenty-five banks in the United States, who control about two-thirds of U. S. banking assets in the country, are already changing their business. Again, they have already moved beyond what Congress and the administration are doing to regulate the banking system.
More important, foreign banks are changing the banking picture in the United States. Currently, foreign branches control about 11% of the total banking assets in the country. I have already stated that this will increase to 15% to 20% over the next five years or so. We see this expansion taking place before our eyes. Yesterday “China Finds a New Market for Loans: U. S.” (See http://online.wsj.com/article/SB10001424052748703957604575273011917977450.html#mod=todays_us_money_and_investing.) Today, “China Bank IPO, Possibly Biggest Ever, Set for July.” (See http://online.wsj.com/article/SB20001424052748704875604575281690877047522.html#mod=todays_us_money_and_investing.) And, don’t forget the sovereign wealth funds, huge accumulators of money.
The world of finance is changing because the incentives affecting finance are changing all over the world. I can’t even imagine what this world will look like with instantaneous trading, further ‘slicing and dicing’ of cash flows and other financial information, greater use of information theory to detect trading patterns (see my book review of “The Quants”, http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson), and more and more information markets popping up around the world (see Robert Shiller’s book “The New Financial Order: Risk in the 21st Century”)!
In the field of Complexity Theory, researchers speak of times like this when systems go through the process they call “Emergence” and “Self-Organization.” It is during times like these that one structural system is transitioning into another structural system. The problem is that no one, before-the-fact, can predict how existing information systems combine with other information to produce the resulting system. Systems just “self-organize” and a new system “emerges” from what was formerly un-organized.
This appears to be what is happening now. The movement of “hotshot” traders is one piece of evidence of this. The restructuring of the big banks is another piece of evidence. The response of hedge funds to the Congressional threat to change how partners are paid is evidence of this. The changes in financial regulations around the world is evidence of this. The growth and increased aggressiveness of Chinese banks is evidence of this. And, so on and so forth.
Congress is just speeding this change along. However, they better be careful about what they wish for because my best guess is that what they get will be nothing like what they are planning for.
Showing posts with label Niall Ferguson. Show all posts
Showing posts with label Niall Ferguson. Show all posts
Thursday, June 3, 2010
Thursday, March 19, 2009
The Fed Moves to Monetize
The Federal Reserve shocked the financial markets yesterday. The Fed released the results of its just-ended Federal Open Market Committee meeting and the response was immediate—stock market indices went up—and the value of the dollar went down!
The reason—the Open Market Committee approved a plan to purchase up to $300 billion of longer-term Treasury securities over the next six months. This is in addition to a plan to increase the Fed’s purchase of up to an additional $750 billion of agency mortgage-backed securities.
The stock markets took this surprise as a positive sign that the Fed was being true to what Chairman Ben Bernanke had indicated in recent speeches and interviews—“the Federal Reserve will employ all available tools to promote economic recovery.” (Oh, he also added “and to preserve price stability.”) Good news—right? Well, the stock market seemed to be “mixed” today.
The foreign exchange markets took another view and the value of the dollar dropped sharply, and the selloff was “widespread” according to the Wall Street Journal. Bad news—right? Well, the value of the dollar continued to decline today.
It is a complex story. I have been one that has continuously expressed concern over the long term prospects for the dollar in foreign exchange markets. See for example my post “The Obama Stimulus Plan and the Dollar: Is There a Connection (http://seekingalpha.com/article/114310-the-obama-stimulus-plan-and-the-dollar-is-there-a-connection). The concern is over the huge United States budget deficit and how this deficit is to be financed in future years. The long-run view of such large deficits is that a substantial portion of them will have to be monetized by the central bank. The fundamental effort of all Keynesian fiscal policy is to inflate or reflate the economy.
There are some complicating factors to this simple story. Through all the financial and economic turmoil of the past six months the dollar has not declined in value but has actually strengthened. If participants in the financial markets are so concerned about the deficits of the United States government and the possibility that the Federal Reserve will monetize a bunch of the debt, why has the value of the dollar gone in the direction it has? Why hasn’t the value of the dollar tanked, instead?
For one, the United States dollar is the “world” currency and it still is the currency of choice in times of uncertainty and turmoil. Thus, the strength of the dollar has, to a large extent, been the result of a “flight to safety” on the part of many investors in the world. It will, undoubtedly, continue to be a “safe haven” for much of the world’s wealth for a long while into the future.
Second, because most of the whole world is in some kind of a recession and are following similar fiscal and monetary policies, it becomes difficult to discern which currencies throughout the world are going to be the worst off. If changes in the value of currencies are a result of changes in the relative prospect for future inflation in different countries, then the exchange rates will ultimately be dependent upon just how each of these countries handles the pressures created by their own stimulus packages.
As for the United States dollar, the most important factor determining its value in the near term is going to be the “safety” factor. Still, other factors, like the aggressive posture of the Federal Open Market Committee cannot be ignored. And, this seems to be what is happening right now in foreign exchange markets. I would argue that even though this latter movement might be a short-run phenomenon, a person concerned with the future health of the United States economy should not ignore what the foreign exchange market might be telling us.
I continue to go to this statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership,” (New York: Times Books, 1992), p. 232.) Consequently, what is happening or will happen to this price should be of major concern to investors. This price will carry with it the view of the world investment community about how the United States is conducting its fiscal and monetary policies.
This is something that the Obama administration and the Federal Reserve System need to pay attention to. The most recent example of ignoring information like this came during the years of the Bush administration. In 2001 a tax cut was passed by the government that took the government budget from a surplus to a deficit position. This was followed by increasing expenditures that went to support several military engagements around the world. The fundamental market response to this was that the value of the dollar began to decline early in 2002.
In addition to this the Federal Reserve System kept short term interest rates at very low levels (the effective Federal Funds rate was below 2% from early in 2002 until the beginning of 2005) for an extended period of time which resulted in negative real rates of interest during this interval. Participants in foreign exchange markets continued to put pressure on the value of the dollar into the summer of 2008. Even though officials in the Bush administration and the Federal Reserve System claimed that they were watching the value of the dollar and maintaining its value was an important goal, little or nothing was done about this decline and the market value continued to sink.
The value of the dollar is something that we need to continue to watch closely. The concern over the monetary and fiscal policies of the Obama administration is not misplaced. A warning shot was issued this week by the Chinese Premier Wen Jiabao when he indicated that he was a “little bit worried” about the safety of the U. S. Treasury bonds that his government owns. The reaction of the foreign exchange market to the Fed’s announcement about their plan to buy up to $300 billion of longer-term Treasury securities is another. And, there is also the concern of some analysts that the real financial and economic issue facing the United States is one of “too much debt” and that this debt overload is exacerbating the economic slowdown. As the historian Niall Ferguson, author of “The Ascent of Money” (see review at http://seekingalpha.com/article/120595-a-financial-history-of-the-world), has stated, “the solution to the problem of having too much debt around is not creating more debt.”
Is the decision of the Federal Open Market Committee to purchase up to $300 billion of longer-term Treasury issues the next step in the monetizing of the debt? Will the release of this information contribute to a further decline in the value of the dollar? There are, of course, a lot of “known unknowns” and “unknown unknowns” at this time. Obviously, it is a very risky time. However, in my view, eventually the value of the dollar will continue to erode. History has shown that this is what eventually happens in situations like the one we are in.
The reason—the Open Market Committee approved a plan to purchase up to $300 billion of longer-term Treasury securities over the next six months. This is in addition to a plan to increase the Fed’s purchase of up to an additional $750 billion of agency mortgage-backed securities.
The stock markets took this surprise as a positive sign that the Fed was being true to what Chairman Ben Bernanke had indicated in recent speeches and interviews—“the Federal Reserve will employ all available tools to promote economic recovery.” (Oh, he also added “and to preserve price stability.”) Good news—right? Well, the stock market seemed to be “mixed” today.
The foreign exchange markets took another view and the value of the dollar dropped sharply, and the selloff was “widespread” according to the Wall Street Journal. Bad news—right? Well, the value of the dollar continued to decline today.
It is a complex story. I have been one that has continuously expressed concern over the long term prospects for the dollar in foreign exchange markets. See for example my post “The Obama Stimulus Plan and the Dollar: Is There a Connection (http://seekingalpha.com/article/114310-the-obama-stimulus-plan-and-the-dollar-is-there-a-connection). The concern is over the huge United States budget deficit and how this deficit is to be financed in future years. The long-run view of such large deficits is that a substantial portion of them will have to be monetized by the central bank. The fundamental effort of all Keynesian fiscal policy is to inflate or reflate the economy.
There are some complicating factors to this simple story. Through all the financial and economic turmoil of the past six months the dollar has not declined in value but has actually strengthened. If participants in the financial markets are so concerned about the deficits of the United States government and the possibility that the Federal Reserve will monetize a bunch of the debt, why has the value of the dollar gone in the direction it has? Why hasn’t the value of the dollar tanked, instead?
For one, the United States dollar is the “world” currency and it still is the currency of choice in times of uncertainty and turmoil. Thus, the strength of the dollar has, to a large extent, been the result of a “flight to safety” on the part of many investors in the world. It will, undoubtedly, continue to be a “safe haven” for much of the world’s wealth for a long while into the future.
Second, because most of the whole world is in some kind of a recession and are following similar fiscal and monetary policies, it becomes difficult to discern which currencies throughout the world are going to be the worst off. If changes in the value of currencies are a result of changes in the relative prospect for future inflation in different countries, then the exchange rates will ultimately be dependent upon just how each of these countries handles the pressures created by their own stimulus packages.
As for the United States dollar, the most important factor determining its value in the near term is going to be the “safety” factor. Still, other factors, like the aggressive posture of the Federal Open Market Committee cannot be ignored. And, this seems to be what is happening right now in foreign exchange markets. I would argue that even though this latter movement might be a short-run phenomenon, a person concerned with the future health of the United States economy should not ignore what the foreign exchange market might be telling us.
I continue to go to this statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership,” (New York: Times Books, 1992), p. 232.) Consequently, what is happening or will happen to this price should be of major concern to investors. This price will carry with it the view of the world investment community about how the United States is conducting its fiscal and monetary policies.
This is something that the Obama administration and the Federal Reserve System need to pay attention to. The most recent example of ignoring information like this came during the years of the Bush administration. In 2001 a tax cut was passed by the government that took the government budget from a surplus to a deficit position. This was followed by increasing expenditures that went to support several military engagements around the world. The fundamental market response to this was that the value of the dollar began to decline early in 2002.
In addition to this the Federal Reserve System kept short term interest rates at very low levels (the effective Federal Funds rate was below 2% from early in 2002 until the beginning of 2005) for an extended period of time which resulted in negative real rates of interest during this interval. Participants in foreign exchange markets continued to put pressure on the value of the dollar into the summer of 2008. Even though officials in the Bush administration and the Federal Reserve System claimed that they were watching the value of the dollar and maintaining its value was an important goal, little or nothing was done about this decline and the market value continued to sink.
The value of the dollar is something that we need to continue to watch closely. The concern over the monetary and fiscal policies of the Obama administration is not misplaced. A warning shot was issued this week by the Chinese Premier Wen Jiabao when he indicated that he was a “little bit worried” about the safety of the U. S. Treasury bonds that his government owns. The reaction of the foreign exchange market to the Fed’s announcement about their plan to buy up to $300 billion of longer-term Treasury securities is another. And, there is also the concern of some analysts that the real financial and economic issue facing the United States is one of “too much debt” and that this debt overload is exacerbating the economic slowdown. As the historian Niall Ferguson, author of “The Ascent of Money” (see review at http://seekingalpha.com/article/120595-a-financial-history-of-the-world), has stated, “the solution to the problem of having too much debt around is not creating more debt.”
Is the decision of the Federal Open Market Committee to purchase up to $300 billion of longer-term Treasury issues the next step in the monetizing of the debt? Will the release of this information contribute to a further decline in the value of the dollar? There are, of course, a lot of “known unknowns” and “unknown unknowns” at this time. Obviously, it is a very risky time. However, in my view, eventually the value of the dollar will continue to erode. History has shown that this is what eventually happens in situations like the one we are in.
Wednesday, February 11, 2009
The Three Problems We Face: Debt, Debt, and Debt!
The focus is wrong. The focus is on the demand side of the economy. As John Maynard Keynes argued, “most practical men are indeed in thrall to the ideas of some long dead economist”…and that long dead economist is John Maynard Keynes. Niall Ferguson refers to the policy makers of today as “born again Keynesians”! And, so the focus remains on stimulating demand.
As a consequence there seems to be a disconnect between what the policy makers are producing in terms of stimulus and bailout and what others, financial markets and individual consumers and families, are experiencing. The debt overhang is stifling everything and this must be corrected before the contraction can be stopped.
This makes the problem in the economy a “supply” problem and not a problem of demand. It is a supply problem because the response to excessive amounts of debt is to save and to reduce leverage. And, this delevering is a cumulative process and either must be overcome by massive inflation…or, it must work itself out.
The explosion of credit is like a house of cards…with the underlying danger being that once the house begins to collapse…the whole house is affected. Given the incentives created by Bush43, the credit pyramid grew. The increases in government debt and the excessively low interest rates maintained by the Greenspan Fed set the standard for the day. And, the private sector followed…the private sector took on more and more risk…and financed their riskier positions with more and more leverage. The whole credit structure became shakier and shakier.
The problem with a house of cards is that once one of the cards on a lower level is removed…the whole house can come down. Experience teaches us that some portions of the house may not collapse…but, if the card removed is at the base of the house…it will likely be the case that a large amount of the house will fall…
The card that was pulled out of the house of cards this time was housing finance. As we know now the subprime market can be identified as the place where the collapse began. But, this level of finance supported a large component of the house of credit in the form of mortgage-backed securities and then other derivative securities and tools that used this base of mortgages as the foundation of the structure. And, the house began to fall.
Of course, we are waiting for other parts of the mortgage house to fall…those connected with the next wave of interest rate re-pricings connected with Alt-A mortgages and options mortgages that will be taking place over the next 18 months or so. And, this does not include other consumer debt like equity lines, credit cards, car loans and so forth. It also does not include the collapse of the banking system and other components of the finance industry.
As we have seen the collapse in the housing market has spread to other areas of the financial market. Contagion is the word to describe this spread. And, the problem has become a world wide problem with problems in financial institutions and beyond throughout the developed world and into the emerging nations.
What is the response to the existence of too much debt?
Well, there are two. The first response is to create inflation. Pour money into the system and artificially create spending so that resources are put back to work…eventually creating sufficient demand so that prices begin rising again. This is the Keynesian way…reduce the real value of the debt outstanding. And, the only way to do this is by “printing money.” If the banking system seems to be clogged up…why then let the Federal government begin to spend…finance the spending by selling Treasury securities…but sell the debt directly to the Federal Reserve where the central bank will just give the Treasury Department a demand deposit at some commercial bank. That is the demand side response.
The other response to the fact that there is too much debt is for people to pull back their expenditures…withdraw from the spending stream…and pay down debt in whatever way they can. This is what is happening now and this has been called historically a debt/deflation. It is basically the process of delevering the economy so that economic units can return to reasonable debt levels on their balance sheet.
Unless people come to believe that the government is going to create a substantial enough inflation to reduce the “real” value of their debt to reasonable levels…they will not stop their attempt to get their lives back in order with a reduced amount of debt on their balance sheets. This is why this process is a cumulative one…a process that eventually must work itself out before the economy bottoms out and a return to growth can occur.
One of solution to this overhang is to write down the debt. I dealt with this issue in my post of February 4, 2009, “Two Painful Proposals to Reduce Our Excess Debt,” http://seekingalpha.com/article/118475-two-painful-proposals-to-reduce-our-excess-debt, so I won’t go into it further here. A plan like this is politically difficult because writing down the debt of those that over-extended themselves looks like we are bailing out the undisciplined or the scoundrels at the expense of the prudent and honest. Such an appearance carries with it severe political risks.
However, if the debt levels have to be reduced at some time…this overhang of excessive debt is going to have to be worked out one way or another. Half-way plans are not going to work. (See my post of February 9, 2009, “Obama Stimulus Plan: Bailout or Wimp Out?”, http://seekingalpha.com/article/119347-obama-stimulus-plan-bailout-or-wimp-out.) The government in Washington, D. C. is going to have to bite-the-bullet sometime…the question is just whether they are going to do it now…or do it later when things get worse.
And, let me just re-enforce my argument of above. Ultimately, this is a supply side problem…not a demand side problem. The attempt to pull off a demand side victory hangs on the balance of when inflation can be restarted and how much inflation can be generated to significantly reduce the “real” value of the debt.
The problem with this effort, however, is that an inflationary environment is one in which the incentive is to add on more debt…just what we are trying to get away from. Hasn’t the experience of the 2000s convinced us that this is not what we want to do?
The problem with supply side solutions is that they take time and are not as showing as are demand side “stimulus plans.” Also, they tend to be directed toward those individuals and organizations that are under a dark cloud these days. For example, there is the proposal put forward by Bob Barro to eliminate the corporate income tax. (See “Government Spending is No Free Lunch,” http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion.)
The stock market did not respond well to the initial showing of the Obama Bank Bailout plan presented by Tim Geithner yesterday. To me this plan is sending mixed signals…mainly because it is on the tepid side. We have a demand side plan…the Obama Stimulus Plan…and we have a plan to cushion the problem of excessive debt…the Obama Bank Bailout Plan. The two plans don’t seem to mesh and give off the signal that the administration has not yet got its act together. The question then becomes…will it get its act together?
The debt issue must be dealt with…and firmly. At this time…firmly is not a word I would use.
As a consequence there seems to be a disconnect between what the policy makers are producing in terms of stimulus and bailout and what others, financial markets and individual consumers and families, are experiencing. The debt overhang is stifling everything and this must be corrected before the contraction can be stopped.
This makes the problem in the economy a “supply” problem and not a problem of demand. It is a supply problem because the response to excessive amounts of debt is to save and to reduce leverage. And, this delevering is a cumulative process and either must be overcome by massive inflation…or, it must work itself out.
The explosion of credit is like a house of cards…with the underlying danger being that once the house begins to collapse…the whole house is affected. Given the incentives created by Bush43, the credit pyramid grew. The increases in government debt and the excessively low interest rates maintained by the Greenspan Fed set the standard for the day. And, the private sector followed…the private sector took on more and more risk…and financed their riskier positions with more and more leverage. The whole credit structure became shakier and shakier.
The problem with a house of cards is that once one of the cards on a lower level is removed…the whole house can come down. Experience teaches us that some portions of the house may not collapse…but, if the card removed is at the base of the house…it will likely be the case that a large amount of the house will fall…
The card that was pulled out of the house of cards this time was housing finance. As we know now the subprime market can be identified as the place where the collapse began. But, this level of finance supported a large component of the house of credit in the form of mortgage-backed securities and then other derivative securities and tools that used this base of mortgages as the foundation of the structure. And, the house began to fall.
Of course, we are waiting for other parts of the mortgage house to fall…those connected with the next wave of interest rate re-pricings connected with Alt-A mortgages and options mortgages that will be taking place over the next 18 months or so. And, this does not include other consumer debt like equity lines, credit cards, car loans and so forth. It also does not include the collapse of the banking system and other components of the finance industry.
As we have seen the collapse in the housing market has spread to other areas of the financial market. Contagion is the word to describe this spread. And, the problem has become a world wide problem with problems in financial institutions and beyond throughout the developed world and into the emerging nations.
What is the response to the existence of too much debt?
Well, there are two. The first response is to create inflation. Pour money into the system and artificially create spending so that resources are put back to work…eventually creating sufficient demand so that prices begin rising again. This is the Keynesian way…reduce the real value of the debt outstanding. And, the only way to do this is by “printing money.” If the banking system seems to be clogged up…why then let the Federal government begin to spend…finance the spending by selling Treasury securities…but sell the debt directly to the Federal Reserve where the central bank will just give the Treasury Department a demand deposit at some commercial bank. That is the demand side response.
The other response to the fact that there is too much debt is for people to pull back their expenditures…withdraw from the spending stream…and pay down debt in whatever way they can. This is what is happening now and this has been called historically a debt/deflation. It is basically the process of delevering the economy so that economic units can return to reasonable debt levels on their balance sheet.
Unless people come to believe that the government is going to create a substantial enough inflation to reduce the “real” value of their debt to reasonable levels…they will not stop their attempt to get their lives back in order with a reduced amount of debt on their balance sheets. This is why this process is a cumulative one…a process that eventually must work itself out before the economy bottoms out and a return to growth can occur.
One of solution to this overhang is to write down the debt. I dealt with this issue in my post of February 4, 2009, “Two Painful Proposals to Reduce Our Excess Debt,” http://seekingalpha.com/article/118475-two-painful-proposals-to-reduce-our-excess-debt, so I won’t go into it further here. A plan like this is politically difficult because writing down the debt of those that over-extended themselves looks like we are bailing out the undisciplined or the scoundrels at the expense of the prudent and honest. Such an appearance carries with it severe political risks.
However, if the debt levels have to be reduced at some time…this overhang of excessive debt is going to have to be worked out one way or another. Half-way plans are not going to work. (See my post of February 9, 2009, “Obama Stimulus Plan: Bailout or Wimp Out?”, http://seekingalpha.com/article/119347-obama-stimulus-plan-bailout-or-wimp-out.) The government in Washington, D. C. is going to have to bite-the-bullet sometime…the question is just whether they are going to do it now…or do it later when things get worse.
And, let me just re-enforce my argument of above. Ultimately, this is a supply side problem…not a demand side problem. The attempt to pull off a demand side victory hangs on the balance of when inflation can be restarted and how much inflation can be generated to significantly reduce the “real” value of the debt.
The problem with this effort, however, is that an inflationary environment is one in which the incentive is to add on more debt…just what we are trying to get away from. Hasn’t the experience of the 2000s convinced us that this is not what we want to do?
The problem with supply side solutions is that they take time and are not as showing as are demand side “stimulus plans.” Also, they tend to be directed toward those individuals and organizations that are under a dark cloud these days. For example, there is the proposal put forward by Bob Barro to eliminate the corporate income tax. (See “Government Spending is No Free Lunch,” http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion.)
The stock market did not respond well to the initial showing of the Obama Bank Bailout plan presented by Tim Geithner yesterday. To me this plan is sending mixed signals…mainly because it is on the tepid side. We have a demand side plan…the Obama Stimulus Plan…and we have a plan to cushion the problem of excessive debt…the Obama Bank Bailout Plan. The two plans don’t seem to mesh and give off the signal that the administration has not yet got its act together. The question then becomes…will it get its act together?
The debt issue must be dealt with…and firmly. At this time…firmly is not a word I would use.
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