This column will outline the worst case scenario that might confront Bad Ben at some time in late 2011, just one year away from the 2012 presidential election. Worst case scenarios are important because they warn us of the most serious consequences that bad economic policies present before they have been fully implemented.
Let us assume that President Obama successfully steers the 2011 budget through an increasingly resistant Congress. Let us further assume that he is successful in securing small scale health ‘reforms’ that add to the overall budget deficit. Let us assume that the 2010 elections return a reduced Senate majority for the Democrats, inclusive of two independent supporters (Specter has gone), of only 52 to 48, with a new Senate Majority Leader (Reid has gone). Let us assume that Nancy Pelosi’s Democrat majority in the House survives by a whisker, with her electorally disastrous leadership under critical threat from within her caucus. President Obama by then has aged 10 years in just two disastrous years in office. By 2012, if my prediction comes true, his hair will be completely white.
Let us assume that, by late 2011, whatever the changes imposed on the financial sector, the banks have restored their financial ratios and, in a slowly recovering economy, are prepared to move decisively into big-time lending. The demand for loanable funds is there, and the money supply – oh the money supply – is very definitely there. Big Labor is on the wage-war path, and Big Business is only too willing to deal. In short, inflationary expectations are on the rise, and are exacerbated by a relentless weakening of the US dollar.
What will Bad Ben do? Well, we can be sure that he will not engage in open-market operations, selling off his toxic assets at yard sale prices in a doomed attempt to mop up the money supply; an attempt that assuredly would bring down the private housing market once again, and that would also collapse the commercial mortgage market. We can also assume that he will not bankrupt the Fed by selling off all his Treasury notes. No, sitting at the poker table on a diminishing pile of borrowed chips, a visibly sweating Fed Chairman will predictably attempt to buy off those who threaten his survival: he will boost interest payments to banks on the reserves they hold in their vaults.
Bad Ben will try to suppress the income velocity of circulation of the excessive quantity of money with which the Fed has flooded the economy. Because inflationary expectations are on the rise, the Fed must now tread a treacherous path. If interest rates for banks to hold on to their reserves are too high, there goes economic recovery, and with it all propects for an Obama second-term. If they are too low, inflationary expectations will soar and with them the nominal interest rates that Bad Ben must pay out to the banks. Remember that for Bad Ben to fund such protection outlays, the Fed will have to resort to the printing press, since it dare not sell back its toxic assets or its Treasury notes. This is a first-step to hyper-inflation as my earlier column on that topic clearly explained.
My expectation is that hyper-inflation will be avoided – since that would result in landslide defeats for all incumbent politicians when they faced re-election, and assuredly would force the resignation of all appointed members of the Fed. Instead, the United States economy, once again will confront the specter of stagflation, characterized by high and upward trending inflation, stubbornly high rates of unemployment and a well below trend rate of economic growth. Such troubled times will persist until a sufficient spirit for change emerges within the US electorate and a new Ronald Reagan or Margaret Thatcher emerges to lead the nation back to laissez-faire capitalism.
And no, Sarah Palin will not cut the mustard. She is a populist, not a stateswoman. Sarah Palin is no Ronald Reagan. Most certainly, she is no Margaret Thatcher.
Tags: Ben Bernanke, excess money supply, hyper-inflation, inflationary expectations, interest on bank reserves, political upheaval, reduced Democrat majorities, Sarah Palin
February 8, 2010 at 10:24 am |
What if Obama was successful in getting through the most toxic of his proposals: health insurance reform and the cap and tax? Personally, I think that if such measures do get through the long term consequences will be even worse than the consequences that you are predicting at the present time.
The health proposals that are being pushed through Congress will add trillions of debt onto the population. This is precisely the same as the horrendous Whitlam experiment gone wrong. At the time that Medibank was introduced such reform was not necessary. We had a good affordable insurance system at the time. The similarity to the current USA situation is that the underlying reasons for wanting this reform was for government to get its hands on the reserves held by the health funds. The way in which government was going to pay for this “universal” system would be through taxation – a 1.25% levy was imposed upon taxable income to meet the costs. Of course there was more to the scheme as one of the other intentions was to force doctors and nurses onto salaries. It did not work that way. The system was supposed to introduce bulk billing. The doctor would receive 85% of the scheduled fee (which is the rub because the doctors do not charge the scheduled fee) and this was supposed to be bulk-billed. The obvious result of this measure was a massive rise in fraud. At the same time the government funded some prescription drugs. If the item is not on the free list (today it means paying over $33 per item if it is NHS) then the patient has to pay, sometimes in excess of $100 or go without the medication. The fact remains that the scheme itself is cumbersome and inefficient in the way that it is handled with the patients having fewer options with regard to medical treatment. It is also a drain on the economy.
With this in mind, I believe that Congress should continue to resist the passing of the present legislation. They need to start again, and introduce real reforms…. not the half-baked ideas that have been pushed through Congress. Also the introduction of such a scheme could in fact cripple the economy by exacerbating govt payouts.
The other issue is cap and tax, another scheme that is yet another tax without benefits. One possible reason for persisting in this particular disaster is the creation of a carbon trading scheme out of Chicago. Obviously there are a few people who will benefit from this scheme. Whilst it will bring in some tax revenue, on the other side of the balance sheet will be the diminishing jobs, increases in energy costs and as a result a flow on effect within the economy such that there will be further pressure on rising prices, followed by pressure to increase wages, leading to higher levels of inflation.
For me, personally, I have that deja vu feeling, that I have seen this kind of situation in the past. That past was in the 1970s when we had the first period of stagflation. The policies being pursued by the Obama Administration are very similar to the policies that were pursued by Whitlam in the 1970s, complete with the out of control spending, and lack of fiscal discipline. What the Whitlam government did at the very least, was to exacerbate the stagflation so that it took longer to recover. If the Obama Administration does not reverse its potentially disastrous economic policies then the effects of the coming stagflation will last a lot longer this time around.
Australia has a similar problem today with the KRudd government and its similar lack of good fiscal discipline. When Kevin Rudd came to power the budget was in a surplus. Within 2 years that surplus became a huge deficit because the Treasurer and the Prime Minister have been acting irresponsibly. This includes Australia’s own pork barrel bill called stimulus.
The difference over here though, is that the Reserve Bank does not always follow government direction. The Reserve bank board meets monthly. If they feel it is necessary to apply a little bit of discipline, then there will be an interest rate rise – usually of about 1/4% which has the effect of increasing the cost of credit across the board, especially mortgage interest rates.
What I can see is that the USA Fed is being hampered by the existence of the legislation that insists that banks loan at least 50% of the money available for mortgages to people who cannot afford to pay off the loans. This makes raising the mortgage interest rate very difficult, yet it needs to be done at some time in the near future.
I should point out here that the UK has similar problems and what is worse they have a near zero interest rate which means that people are spending money that should be used to pay down their mortgage. This in turn could lead to further long term pain when these people suddenly find that they do not have the money to meet their deferred obligations.
February 8, 2010 at 4:24 pm |
“avoid hyper-inflation since that would result in landslide defeats for all incumbent politicians when they faced re-election, and assuredly would force the resignation of all appointed members of the Fed.”
I wish I could be so positive in my outlook.
A review of historical governments who suffered hyperinflation, I find few governments overthrown by it. Even the Weimer Republic survived its hyperinflation (the Republic lasted from 1919 to 1933). Many South American governments have muddled through – Chavez being a recent example (though, honestly, it is more high inflation than hyper).
I find, though, many governments – even entire eras – overthrown by economic depression.
I believe that is why modern governments are rabid in avoiding depression/recessions (confusing this with deflation, of course) and apt to engage in inflation (confusing this policy with ‘growth’). It is easier to fool the masses with claims of increasing prosperity by showing them increasing numbers of pieces paper in their wallet. It takes the masses quite a bit of time and attention for them to figure out that paper doesn’t buy very much.
However, hyperinflation in a modern, advanced economy like the USA is unprecedented.
I fear that politicians , reviewing historical experience, will prefer dancing with hyperinflation.
February 8, 2010 at 5:21 pm |
The FED is already announcing that it will raise the interest rate paid to banks to hold their money in reserve rather than lend it, so your prediction is starting BEFORE the mid-term elections rather than after. It will be interesting to see what the short-term results of this are after the first few months.
It is a good thing that Portugal, Ireland, Greece, and Spain are causing a devaluation of the Euro, or the dollar would still be crashing.
My biggest curiostiy right now is that with all of the evidence that the dollar and the euro are both getting closer and closer to worthless simultaneously, why has there been such a pause in gold? I would think gold would be ramping up again with all that we know right now. Of course, the pause gives more smart people a chance to acquire some now before further currency collapse occurs I suppose….
February 8, 2010 at 7:48 pm |
@blagflag, the hyperinflation is also unprecedented in Australia
What I do think is that the American population, being mostly fiscal conservatives will not stand for a situation of hyperinflation.
February 9, 2010 at 6:33 pm |
Great post. It is clear You have a great deal of unused capacity, which you have not turned to your advantage.
The way you write shows you have a need for other people to like and admire you, and yet you tend to be critical of yourself.
It seems to me that while While you have some personal weaknesses you are generally able to compensate for them.