Last week, April 7, 2011 to be exact, things started to change. Jean-Claude Trichet, President of the European Central Bank, guided the ECB to an increase in its policy interest rate, moving from 1.00 percent to 1.25 percent. (See http://seekingalpha.com/article/262429-trichet-delivers-ecb-hikes-its-interest-rate.)
The night before the announcement, Portugal declared that it would seek a bailout from the European Union.
Last Friday evening, President Obama, the United States Senate and the United States House of Representatives reached an eleventh-hour agreement on the 2011 fiscal budget.
Yesterday, President Obama gave a speech laying out his ideas about improving the fiscal position of the United States government in the upcoming future.
Has Trichet and the ECB provided the turning point?
It is not altogether clear that the financial markets believe that the real attitudes in the United States have changed. Since the Trichet announcement, and through the political maneuvering in the United States over the past week, the Euro rose from about $1.42 per Euro to about $1.46 per Euro. Op-ed pieces in the Financial Times have argued that the Americans are really not serious about getting the budget under control. Seems as if people are not convinced yet that there is anyone in the American government that is intent upon really doing something about the situation. They are just posturing.
And, there is one person I have not mentioned that plays a vital role in this scenario: Ben Bernanke.
Bernanke in now on the opposite side of the picture from Trichet. (http://seekingalpha.com/article/261863-the-euro-trichet-vs-bernanke)
Trichet has turned the corner and raised interest rates.
Bernanke continues to promote QE2.
The Europeans cannot fault the Americans for messy governance. Since the sovereign financial cookie began to crumble in Europe in January 2010, the governments in Europe have fallen all over themselves trying to avoid any real fiscal action that would restore order to the national problems of the continent.
This has allowed countries to delay taking real actions that might resolve the European situation.
Then Trichet stepped up. Because of the pending ECB movement, Portugal had to move, they had to show some activity before the rate increase was announced.
Now, other European nations are on notice. Trichet has indicated that the recent move was not necessarily a part of multiple moves in the interest rate. But, I don’t think that any European nation doubts that Trichet and the ECB will continue to raise rates if the troubled nations don’t seriously attack their problems.
As I said, Bernanke is on the opposite side of the picture.
The Bernanke record? Before the Jackson Hole speech in late August (http://seekingalpha.com/article/222704-bernanke-in-the-hole), a Euro could be purchased for about $1.27. By early November, the price of a Euro had climbed to about $1.42. Into January, as the governments of the European Union messed around, this price dropped to around $1.30. Trichet started making noises that maybe the ECB needed to start raising interest rates and this resulted in value of the Euro rising again to around $1.40. And, Bernanke continued to defend the Fed’s quantitative easing!
What is Bernanke holding out for? What does he know about the economy or the banking system we don’t?
Of course, Bernanke has always been late to the dance. He was still promoting excessively low interest rates in the early 2000s when the housing bubble and the stock market bubble were accelerating. He was still fighting inflation in August 2007 as the regime of the Quants broke. He was still worried about inflation in August of 2008 until he wasn’t worried about inflation in September 2010. (See http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Any bets that Bernanke will be late to the party once again?
But, when it comes to the lack of confidence in the will of the United States to support the value of the dollar, Bernanke is not alone. With two exceptions, the United States government has followed a policy of credit inflation for the last fifty years that has resulted in a decline in the value of the dollar against major trading partners of around 35 percent. The value of the dollar has declined against other, non-major trading partners, by even more than 35 percent over this time period.
The two exceptions came when the monetary policy of the United States was led by Paul Volcker, 1979-1987, and the fiscal policy was led by Robert Rubin, 1995-1999. During these periods the value of the United States dollar rose strongly. Yet, overall, the value of the dollar still declined by 35 percent.
And, the United States dollar is the reserve currency of the world. We should be really proud of having this responsibility. And, in carrying out this responsibility the economic policy of the United States government has caused other sovereign nations to lose part of their wealth due to the fact that the United States was inflating their currency and causing a decline in the value of the currency reserves these nations were holding.
For the near term, Bernanke is going to “stay with the fight”. That is quantitative easing is going to be continued through June. Between now and then the “debt ceiling” fight is going to heat up along with the competition now being billed as the “budget debate.”
And, the value of the United States dollar will continue to decline (baring other shocks to the world).
The value of the United States dollar will continue to decline over time as long as the rest of the world believes that we will not get our fiscal house in order and also believes that our central bank will continue to inflate the globe!
How will we know if the rest of the world begins to take our fiscal and monetary responsibilities seriously?
We will know that attitudes have shifted once we begin to see the value of the dollar firm up and even begin to rise on information about growing discipline over the budget and monetary policy. (I have written an Instablog on this: see “What is Needed to Reduce the Federal Deficit,” March 3, http://seekingalpha.com/author/john-m-mason/instablog.)
For now, we hear a lot of platitudes in the budget debate but very little noise of rubber hitting the road. We have a right to remain skeptical.
Showing posts with label debate over the budget. Show all posts
Showing posts with label debate over the budget. Show all posts
Thursday, April 14, 2011
Monday, March 7, 2011
How Much Should the United States Cut the Deficit?
How much should the United States government cut its budget deficit?
This seems to be the big debate in Congress surrounding discussions/negotiations related to the new fiscal budget.
The problem as I see it is that the United States government is focused on the wrong objective! It is focused on an objective, low levels of unemployment that it cannot achieve without creating all other kinds of distortions in the economy, distortions that produce, in many cases exactly the opposite result from what the government is attempting to achieve.
Let me tell you what objective I believe the United States government should focus upon in determining its economic policy stance, which includes its fiscal budget.
I believe that the primary economic focus of the United States government should be on the value of the United States dollar. I believe that the United States government should attempt to stabilize and maintain the value of the dollar in international currency markets.
The current focus of economic policy in the United States government is employment…or low levels of unemployment. This objective was memorialized in The Employment Act of 1946 which set placed the responsibility for achieving high levels of employment, or low levels of unemployment on the back of the United States government.
In 1978 this objective was re-enforced by a new act, The Full Employment and Balanced Growth Act (known informally as the Humphrey–Hawkins Full Employment Act). This act just made stronger the government’s commitment to the achievement of low levels of unemployment.
The ability of a government to achieve full employment was contested in 1968 by the economist Milton Friedman who contended that continued governmental stimulus to achieve a “hypothetical” level of employment, called “full employment” would only achieve more and more inflation as people came to expect the government’s efforts to stimulate the economy through the creation of credit expansion…credit inflation.
Friedman’s expectations proved to be true as the government continued to promote government deficits and the expansion of government debt in economy.
From 1960 through 2010, the gross federal debt of the country expanded at an annual compound rate of more that 7% per year.
From 1960 through 2010, the purchasing power of the United States dollar declined by about 85%.
From 1960 through 2010, the United States removed itself from the gold standard and allowed the value of the United States dollar to float in foreign exchange markets. The value of the United States dollar has declined by more than 30% since it was floated and expectations are for it to decline further.
From 1960 through 2010 under-employment in the United States has gone from a relatively modest number which was not measured at the earlier date to more than 20% in the current environment.
From 1960 through 2010 manufacturing capacity has declined from about 95% to about 75%. The peak capacity utilization has every cycle since the early 1970s has been at lower and lower levels.
From 1960 through 2010 the income distribution of the United States has become dramatically skewed toward the higher levels of income earned. This is the most skewed income distribution curve ever for the United States.
I cannot see how the United States government can continue to keep “full employment” as a goal of its economic policies. Not only has “full employment” not been maintained, it has generated side effects that, it seems to me, has substantially worsened the life of many Americans.
Why should the government substitute the maintenance of the value of the United States dollar as its primary objective for the conduct of its economic policy?
Here I quote Paul Volcker: “a nation’s exchange rate is the single most important price in (the) economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate.” This quote is from Paul Volcker (“Changing Fortunes: the World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten, Times Books, 1992, page 232.)
Yet “ignore large swings in its exchange rate” is exactly what the United States did and is doing. The consequences of ignoring this value? I have reported those above.
By focusing on the level of unemployment the way the United States government did and pursuing an economic policy of credit inflation, the United States government actually weakened the country and hurt its citizens. The “unintended results of good intentions!”
The United States government should not, and realistically cannot, reduce its budget deficit too rapidly. Markets realize that.
But, the United States government must signal that it is changing the objective of its economic policy and is sincerely pursing a path to reduce or even eliminate the credit inflation it has inflected on its country…and the world…for the last fifty years.
My guess is that until international financial markets see this shift in policy objectives and sense a realistic change in the attitudes of the politicians in Washington, D. C. the dollar will continue to decline in value because participants in international financial markets will just see the government continuing to act in the same way it has over the past fifty years, acting in a way that will continue the policy of credit inflation.
And, if the government continues to act in this way, the economic health of the economy will continue to deteriorate and the standing of the United States in the world will continue to become relatively weaker.
In my view the government does not have to reduce the deficit by massive amounts this year. It does, however, have to signal that it is changing its goals and objectives and then provide enough evidence of this change in focus to convince the international financial markets that it is sincere.
In the current political environment, however, this may be too much to ask.
This seems to be the big debate in Congress surrounding discussions/negotiations related to the new fiscal budget.
The problem as I see it is that the United States government is focused on the wrong objective! It is focused on an objective, low levels of unemployment that it cannot achieve without creating all other kinds of distortions in the economy, distortions that produce, in many cases exactly the opposite result from what the government is attempting to achieve.
Let me tell you what objective I believe the United States government should focus upon in determining its economic policy stance, which includes its fiscal budget.
I believe that the primary economic focus of the United States government should be on the value of the United States dollar. I believe that the United States government should attempt to stabilize and maintain the value of the dollar in international currency markets.
The current focus of economic policy in the United States government is employment…or low levels of unemployment. This objective was memorialized in The Employment Act of 1946 which set placed the responsibility for achieving high levels of employment, or low levels of unemployment on the back of the United States government.
In 1978 this objective was re-enforced by a new act, The Full Employment and Balanced Growth Act (known informally as the Humphrey–Hawkins Full Employment Act). This act just made stronger the government’s commitment to the achievement of low levels of unemployment.
The ability of a government to achieve full employment was contested in 1968 by the economist Milton Friedman who contended that continued governmental stimulus to achieve a “hypothetical” level of employment, called “full employment” would only achieve more and more inflation as people came to expect the government’s efforts to stimulate the economy through the creation of credit expansion…credit inflation.
Friedman’s expectations proved to be true as the government continued to promote government deficits and the expansion of government debt in economy.
From 1960 through 2010, the gross federal debt of the country expanded at an annual compound rate of more that 7% per year.
From 1960 through 2010, the purchasing power of the United States dollar declined by about 85%.
From 1960 through 2010, the United States removed itself from the gold standard and allowed the value of the United States dollar to float in foreign exchange markets. The value of the United States dollar has declined by more than 30% since it was floated and expectations are for it to decline further.
From 1960 through 2010 under-employment in the United States has gone from a relatively modest number which was not measured at the earlier date to more than 20% in the current environment.
From 1960 through 2010 manufacturing capacity has declined from about 95% to about 75%. The peak capacity utilization has every cycle since the early 1970s has been at lower and lower levels.
From 1960 through 2010 the income distribution of the United States has become dramatically skewed toward the higher levels of income earned. This is the most skewed income distribution curve ever for the United States.
I cannot see how the United States government can continue to keep “full employment” as a goal of its economic policies. Not only has “full employment” not been maintained, it has generated side effects that, it seems to me, has substantially worsened the life of many Americans.
Why should the government substitute the maintenance of the value of the United States dollar as its primary objective for the conduct of its economic policy?
Here I quote Paul Volcker: “a nation’s exchange rate is the single most important price in (the) economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate.” This quote is from Paul Volcker (“Changing Fortunes: the World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten, Times Books, 1992, page 232.)
Yet “ignore large swings in its exchange rate” is exactly what the United States did and is doing. The consequences of ignoring this value? I have reported those above.
By focusing on the level of unemployment the way the United States government did and pursuing an economic policy of credit inflation, the United States government actually weakened the country and hurt its citizens. The “unintended results of good intentions!”
The United States government should not, and realistically cannot, reduce its budget deficit too rapidly. Markets realize that.
But, the United States government must signal that it is changing the objective of its economic policy and is sincerely pursing a path to reduce or even eliminate the credit inflation it has inflected on its country…and the world…for the last fifty years.
My guess is that until international financial markets see this shift in policy objectives and sense a realistic change in the attitudes of the politicians in Washington, D. C. the dollar will continue to decline in value because participants in international financial markets will just see the government continuing to act in the same way it has over the past fifty years, acting in a way that will continue the policy of credit inflation.
And, if the government continues to act in this way, the economic health of the economy will continue to deteriorate and the standing of the United States in the world will continue to become relatively weaker.
In my view the government does not have to reduce the deficit by massive amounts this year. It does, however, have to signal that it is changing its goals and objectives and then provide enough evidence of this change in focus to convince the international financial markets that it is sincere.
In the current political environment, however, this may be too much to ask.
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