Inflation Itself Caused the Credit Bubble?

Martin Wolf analyzed a recent GS research paper. Conclusion: Inflationary policies under Bush/Greenspan led to the credit bubble. How: inflation here decreased savings and increased borrowing.

Net result: inflation led to inflation, which led to devaluation (naturally, as a correction), but which has led to drastic inflationary policies to prevent depression. Maybe those gold bugs got it right after all.

If America can't compete globally as a manufacturer or farmer, our economy is doomed to stagnation, decreased wages, and general loser-ness.

Definition of Leadership

I found this on Paul Kedrosky's blog. Naturally, he defined it as group think/mob behavior. I'm an optimist. The first dancer is a leader.

Bond War: Krugy, Fergy, and Grossy

Daniel Gross opined on the ongoing battle to interpret the spike in long-term T-Bill rates. Is the spike a signal from the market that the USG's long term health is at risk (Ferguson's view)? Or, does it signal a retreat from safety (Krugman's view)?

My take on the matter was that it was a combination of factors. There are technical reasons to take cash out of 30 year Treasurys and reinvest them in foreign denominations. Namely, the US will lead the recovery, but it will still face a long and painful period of economic stagnation. This US-led recovery will enable smaller, more vibrant economies to flourish. In the short run, it will keep China afloat. In the long run, though, this means the US equity market and currency is overvalued. For an investment, it makes sense to take some portion out of the US.

I have come to realize, also, that many big money investors are extremely ideological and are tied to long-standing perceptions that Democrats are bad for business, despite the historical trends that suggest otherwise. There are bond vigilantes. They are Bernanke's audience.

Gross offers a rather different point of view, and one that I find convincing:

Both the Fergusonians and the Krugmanites (of whom I count myself one) err in
reading too much into short-term fluctuations in bond prices. There's so much
more at work. Randall Forsyth of Barron's explains a technical reason for the short-term spike in 10-year and 30-year rates. Banks and financial institutions that own mortgages hedge their exposure to refinancing by buying and selling Treasury bonds. When mortgage rates start to rise, as they've done in recent weeks, institutions do
the opposite and sell. "While mortgage investors previously had bought
noncallable Treasuries to offset the risk of their mortgages, mortgage investors
have unwound that hedge, selling their Treasuries," Forsyth writes.

If nothing else, this three-way exchange demonstrates the difference between finance and economics.

This

The Dollar -

Someone sent out the hounds, using fear of a weakening dollar as propaganda against the administration's policies. Yet as I have mentioned before, problems persist in the global economy (especially the European part of it). All major currencies will have to devalue themselves in the coming months. As the business cycle continues its downward trajectory, wise big money investors will continue to see the dollar as a safe haven.

Scorecard: America still leading by a nose. Chinese horse soon to be disqualified for steroids. European entry suffering from anemia. Latin American horses unsure whether the race track runs clockwise or counterclockwise. Indian steed making gains. Vitamin-rich Canadian and Australians making promising strides. Poor, limping Japanese mount -- why can't it catch a break?

Note for the Medievalists, aka Gold Standard Dummies

Hello Ron Paul moonies, I would just like to point out that a gold standard can be manipulated in exactly the same ways as a fiat currency. Market forces have no more impact on a gold-based currency than a fiat currency.

Those who favor a return to the gold standard (you know, the good ol' days before 1933) are in the same position as certain French or Japanese nobles were during the 16th century, arguing in favor of heavy infantry in a gunpowder age. The French adapted and became a world power for several centuries. The Japanese closed their borders and became a backwater until reality hit them in the face.

Like it or not, we live in a world where central banks wield enormous power. The policies of these central banks are transnational in effect. Coordination amongst these banks (undemocratic actions indeed) are necessary to prevent systemic collapses.

What we have learned in this crisis should reify the role of the central bank in international conflict resolution. Watch in the coming months as China gets pressured into the modern world as the coordinated quantitative easing by the Fed, the ECB, and the various national European central banks forces the renmimbi up in value.

Jobs, and a Call for Revolution

Bridgewater and John Mauldin are spreading the word. As I have mentioned before, the only priority right now should be job creation and establishing a backstop for the unemployed. This is all that matters right now. Forget North Korea and Iran. Let the DoJ handle the torture issue. Let FDIC raise funds for the eventual disintegration of one or more of the big banks.

Jobs.

Without them, we'll plunge into a depression that will destroy the Union of 50 States. Without them, the world economy will step back thirty years.

Here's what a Bridgewater analyst says:

“Normally, labor markets lag the economy because incremental spending
transactions are financed via debt, stimulated by interest rate cuts. But as
long as credit remains frozen, spending will require income, and income comes
from jobs. And debt service payments are made out of income. Therefore, in a
deleveraging environment job growth becomes an important leading, causal
indicator of demand and other economic conditions."

In short, fixing finance won't fix the economy. This is a very important point to digest. Wall Street and the markets attract the big media buzz, and the Fed/Treas/SEC/FDIC are dedicated to the repair and growth of Dow Jones. They will all fail if Obama does not zero in on the jobs issue.

All unemployment benefits need to be extended indefinitely. This will be the only way to allow the country to delever and devalue still-bubbled assets. Companies that came in above expectations for Q1 did so on the cost-cutting power of layoffs. Sad, but true. There needs to be more of it. A lot more of it.

Is this contrary thinking to my shrill cry for more jobs? No. We need a backstop for job loss. We need to let companies regain their footing in a world where everything's being re-priced.

At the same time, we need to give the recently unemployed the opportunity for new ventures. Health care costs and business startup costs must be made reasonable. The recently unemployed have skills and experience that should not be put to waste. Untold innovation and improvement is being kicked to the curb.

I am calling for revolution. A small business revolution.

Obama Reading Roubini?

I guess the President was reading Roubini's NYTimes Op-Ed.

President Barack Obama, calling current deficit spending “unsustainable,” warned of skyrocketing interest rates for consumers if the U.S. continues to finance government by borrowing from other countries.

“We can’t keep on just borrowing from China,” Obama said at a town-hall meeting in Rio Rancho, New Mexico, outside Albuquerque. “We have to pay interest on that debt, and that means we are mortgaging our children’s future with more and more debt.”

Holders of U.S. debt will eventually “get tired” of buying it, causing interest rates on everything from auto loans to home mortgages to increase, Obama said. “It will have a dampening effect on our economy.”

Thankfully, he doesn't make the mistake of saying the sky is falling on the dollar and instead places the emphasis on the fiscal component -- too much borrowing.

I sometimes wonder if it would make more sense for the US to default now rather than try to pay back all the obligations. Chapter 11, national style. If we had the national will to accept a lower standard of living and become an exporter nation, defaulting would be feasible. As it is, though, it would just be chaos.

So, everyone, rally around a reduction in spending. Or a sizeable increase in taxes. It comes down to a simple couple of questions: do you want less, or do you want to pay for what you're getting?