Streetwise Professor

February 4, 2011

Let Them Eat Cake

Filed under: Commodities,Economics,Politics — The Professor @ 10:15 am

Fed Chairman Ben Bernanke’s flippancy in dealing with serious questions is becoming more and more disturbing.  He responded to legitimate questions about the credibility of the Fed’s promises to cut back on its expansive policies if inflation appears to be picking up by saying that he could raise interest rates in five minutes, if need be.  Procedurally, this is true, but substantively, this is a non-answer because it completely ignores the credibility issue: would the Fed have the political will to implement controversial rate hikes when the economy is still less than robust (as today’s employment report makes plain)?

But yesterday his flippancy soared to new levels (sort of like the monetary base and the Fed balance sheet).  In response to questions about the effects of QE2 on inflation around the world–notably food price inflation that has helped spark unrest in Egypt and elsewhere–Bernanke was dismissive:

Answering questions after a speech at the National Press Club in Washington, Mr Bernanke said that rising food prices in the emerging world reflected the growing wealth of their populations and, in some countries, a failure to tackle inflation.

“They can, for example, use monetary policy of their own. They can adjust their exchange rates, which is something that they’ve been reluctant to do in some cases,” Mr Bernanke said.

Here’s more:

“I think it’s entirely unfair to attribute excess demand pressures in emerging markets to U.S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries,” he said in answering a question from the audience. “It’s really up to emerging markets to find appropriate tools to balance their own growth.”

Here’s an analogy.  Neighbor Ben is lighting bonfires in his yard in a windstorm.  He responds to your complaints that the flames and sparks from his fire have torched your bushes and threaten to set your house alight by saying: “You have all the tools you need to address the problem.  You could buy a fire extinguisher.  You could soak down the roof of your house.  You could move.”

Food price spikes in particular have been fueled largely by supply shortages, but the boom in commodity prices is so widespread–from copper (now over $10K/tonne) to oil ($100+ for Brent), to cotton (leading to an extraordinary exchange intervention) that it is difficult to deny that expansive US monetary policy has something to do with it.  I say again.  Bernanke has justified QE2 by citing deflationary fears: when–ever–has a deflationary cycle been accompanied by spiking commodity prices?  Usually commodity prices plunge the most.  At least, this should be sparking some cognitive dissonance, a recognition that this isn’t your grandfather’s Depression–even if said Depression was the focus of your academic research.  (Generals fighting the last war are very dangerous–to their own side.)

Bernanke is also rhetorically slippery.  He says that “it is entirely unfair to attribute excess demand pressures in emerging markets to U.S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries.”  That is a non sequitur.  It is entirely possible–and indeed extremely plausible–that US monetary policy has a lot–a lot–to do with excess demand pressures in emerging markets.  That’s the underlying shock: at least it’s one, big, undeniable shock.  The channels of transmission are plainly evident.  Whether countries have the policy tools to respond to that excess demand is an entirely different issue; whether they use them is another.  The source of excess demand pressures and the response to it are completely distinct.  Your failure to buy a fire extinguisher to defend yourself against Neighbor Ben’s pyromania does not mean that the pyromania is an illusion.  It is illogical to claim that because countries have not responded to X the way Bernanke would prefer, X therefore does not exist.  And QE2 is the big X factor.

Bernanke may have let the cat out of the bag and revealed an important–but not publicly emphasized–rationale for QE2 in his remark that countries “can adjust their exchange rates.”  Namely, this suggests that QE2 is intended primarily to reduce the value of the dollar.  To put pressure on countries–most notably China–to let their currencies rise relative to the dollar.  By a lot.  This is, in essence, a big game of chicken between Bernanke and policy makers around the globe–and most importantly, in Beijing.

Inflation is painful.  Currency appreciation brings its own kinds of pain, in the short run, anyways.   Countries are understandably–predictably–reluctant to let it happen.  QE2 has put them between a rock and a hard place.  And the choice is particularly discomfiting in China.  The Chinese have their own rather deep concerns about the robustness of the economy and the potential for social unrest.  Moreover, historical grievances and a current sense of ascendency make them particularly reluctant to knuckle under to the US.  So the game of chicken is likely to continue, and end with a crash rather than a saving swerve by the Chinese.

But even if the game is between the US (and the Fed in particular) and China, the repercussions are global in scope.  The collateral damage is already large, and threatens to spin out of control.  We are in a Year of Living Dangerously, and despite Bernanke’s flat (but illogical) denials, a major source of that danger is US monetary policy.

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21 Comments »

  1. Craig,
    libertarian economist Bill Woolsey has posted a very good defense of Bernanke, and he answers this question: “Why are many free market economists so critical of the Fed’s proposed quantitative easing?”:

    http://monetaryfreedom-billwoolsey.blogspot.com/2010/11/why-so-many-critics-of-qe2.html

    Comment by The Money Demand Blog — February 4, 2011 @ 1:29 pm

  2. Thanks, MDB–I’ll give it a look.

    The ProfessorComment by The Professor — February 4, 2011 @ 4:48 pm

  3. Didnt the Chinese start the currency war long ago? Perhaps Ben in trying to even it a little. Inflation does eff up relative prices. And in several emerging markets, it might not be a bad idea to start updating the relative prices and labor costs and also revise exchange rates. This might result in the US being able to export and produce more.

    Comment by Surya — February 4, 2011 @ 7:29 pm

  4. Let me repeat: the US government will never be able to repay the $14 trillion in debt. The only solution is to print dollars (say, $14 trillion) until they aren’t worth the paper they are printed on.

    Comment by Ostap Bender — February 6, 2011 @ 6:00 am

  5. Stanford’s Ron McKinnon addressed this issue in a January 18 WSJ article, “The Latest American Export, Inflation:” http://online.wsj.com/article/SB10001424052748704405704576064252782421930.html?mod=WSJ_Opinion_LEADTop (subscription required).

    Citing the 2003-04 Greenspan-Bernanke “interest rate shock” and QEII (and, tangentially, 1970’s stagflation), McKinnon argued: “Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.” It certainly sounds like a plausible transmission theory, but I haven’t seen much response to the article.

    Comment by lb100 — February 7, 2011 @ 2:25 am

  6. @Ostap – Of the $14T in outstanding federal debt securities, only about $9T is held by the public. Next time you repeat your idea to monetize $14T in debt, don’t forget to take that into account.

    Comment by Charles — February 7, 2011 @ 6:34 am

  7. Charles, Ostap is not that clever, or honest, in case you hadn’t noticed.

    Very good point by the way.

    Comment by Andrew — February 7, 2011 @ 6:38 am

  8. @Andrew –

    When I saw how simplistic his “only solution” was, I guessed he was either a member of Congress or was on Obama’s economic advisory team. I am, however, interested in his solution to the problem unfunded future liabilies. It seems like it would be good for a laugh.

    Comment by Charles — February 7, 2011 @ 8:04 am

  9. It seems that quantitative easing is the only way for the FED to play it safe. If inflation really goes out of control, that will lower the debt. The U.S. Treasury will have more taxpayer’s money to cope with less past debt. In case they will cut spending by that time to zero. Else, by the time a big inflationary wave hits the U.S., nobody will want U.S. treasuries or bonds. And worse, what will the importing U.S. economy offer for the goods?

    So their only hope is to keep persuading the markets and rating agencies that their debt is safe, because now, it is. The Federal government makes enough cash to start repaying it. But it isn’t, and that’s what worries me.

    Comment by Lorne Marr — February 7, 2011 @ 12:39 pm

  10. @lb100. I was going to cite to the McKinnon piece, but couldn’t find it immediately. I pretty much agree with a lot of what he says.

    @Lorne–inflating reduces the real value of the debt. This helps taxpayers (who have a lower real burden to pay back) but hurts those who own the debt. It’s by no means clear what the net effect of that wold be. Main effect of inflation is redistributive, and you can’t ignore the fact that inflation has deadweight costs–people spend real resources to avoid inflation, search costs are higher, relative prices are distorted and on and on.

    The ProfessorComment by The Professor — February 7, 2011 @ 2:42 pm

  11. @ Charles, I couldn’t agree more.

    Ostap certainly is simple enough to be on that team of blunderers.

    I mean anyone who defends the USSR……..

    Comment by Andrew — February 7, 2011 @ 11:56 pm

  12. Even at current levels, the US debt would, by historical precedent, be more than manageable in the longterm under the conditions that (1) there’s a politically credible path back to fiscal balance or (2) expectation of good growth rates.

    The problem is that it doesn’t appear to have either.

    Comment by Sublime Oblivion — February 8, 2011 @ 2:13 am

  13. @Charles who wrote: “Of the $14T in outstanding federal debt securities, only about $9T is held by the public.

    Please specify what exactly you mean here.

    Next time you repeat your idea to monetize $14T in debt, don’t forget to take that into account.

    What difference does it make if the debt is to the “public” or to the “non-public”? Debt, whomever it’s owed to, has to be repaid, and with interest.

    When I saw how simplistic his “only solution” was, I guessed he was either a member of Congress or was on Obama’s economic advisory team.

    This was not my solution. That was my prediction as to how the Feds will solve the debt problem: by printing money and creating hyper-inflation. I was being sarcastic.

    …. I guessed he was either a member of Congress or was on Obama’s economic advisory team.

    Exactly my point: the Congress and the President will solve the debt problem by printing money. They have already been doing that with gusto. And by “President” I don’t mean just Obama. The Presidents after him will also do so.

    I am, however, interested in his solution to the problem unfunded future liabilies. It seems like it would be good for a laugh..

    I have explained my solution many times here. It’s hardly an original one: fiscal discipline. For example, had Pres. Reagan and then Bush not started to spent money like there were to be no tomorrow in 1983 or so, had Clinton and Bush Jr. not wasted $trillions on wars and wasteful military over-spending, our debt today would be manageable.

    http://www.brillig.com/debt_clock/faq.html

    Of course, we can’t go back in time. What can we do now, other than print money? Cut military spending. Put a moratorium on starting new wars. Increase taxes on those who can afford them. Stop sending many-many $billions in aid to our “friends” (read: those who hate us) running places like Egypt and Pakistan. Stop the insane “war on drugs”. Decriminalize marijuana and tax its sales. Stop the situation where US consumers are forced to pay many times more for the same medicines than people in Canada and most other countries. That is, peg the US prices to the prices that the drug companies settle on with the Canadian and other governments. Reduce/eliminate corn and other agricultural subsidies and the destruction of foods. Move unemployment and welfare programs towards workfare. Improve education and introduce competition to secondary education through vouchers. All kinds of other common sense actions that the Libertarians have been advocating for decades and even centuries. Read more here:

    http://www.cato.org/

    However, I don’t think that the Libertarian desire for lower taxes can be implemented yet. We need to reduce the budget before cutting taxes. I am not saying that the top marginal tax rate should be like it was from 1932 to 1950 – in the 60%s, 70%s, 80%s and 90%s. Nor like it was from 1951 to 1963: about 91%. Nor the 1960s and 1970s when it was around 70%. But the 1982 to 1986 rate – 50% – would be a good marginal tax for people with, say, more than $700 000 in annual income, and 40% would be a good figure for people with more than $500 000.

    http://www.truthandpolitics.org/top-rates.php

    However, the US public and the special interest groups will never agree to cut spending or to raise taxes, until and unless the economy collapses. Especially, raising taxes on the very rich, because most US voters are “Joe the plumbers”: they think that despite their lack of education and their current low-income dead-end jobs, one day they will suddenly wake up millionairs and owning profitable companies with hundreds of employees, all unclogging toilets under our wise management. Sort of, the pollyannaish version of Kafka’s Metamorphoses.

    Thus, a collapse is in the cards for us.

    Look, the correct long-term policy is to drastically cut the Federal spending (especially the bloated military budget) and to lower taxes for everyone. But until the spendings are rfeduced and debt greatly diminished, money has to come from somewhere, and it is better for it to come from the incomes of very rich people (like the bonuses of Wall Street executives and even low-level traders) than funded through more debt or through money printing.

    It seems like it would be good for a laugh..

    If idiots like you stopped laughing at the libertarian ideas and tried them out, the world would be a much better place. For an introduction to theses issues, I recommend reading and watching David Stockman, Reagan’s budget director and the man who, sadly, is partially responsible for some of the US debt. Evidently, he has learned from his past mistakes:

    http://www.colbertnation.com/the-colbert-report-videos/367134/december-02-2010/david-stockman

    Thursday, December 2, 2010
    David Stockman
    David Stockman wants America to get out of debt by letting the Bush tax cuts expire and cutting the defense budget. (06:39)

    http://en.wikipedia.org/wiki/David_Stockman

    Quotes

    “I invest in anything that Bernanke can’t destroy, including gold, canned beans, bottled water and flashlight batteries.”[14]

    “(Extending the Bush tax cuts is) rank demagoguery. We should call it for what it is. If these people were all put into a room on penalty of death to come up with how much they could cut, they couldn’t come up with $50 billion, when the problem is $1.3 trillion. So, to stand before the public and rub raw this anti-tax sentiment, the Republican Party, as much as it pains me to say this, should be ashamed of themselves.”[15]

    “The number-one source of gun violence in America is the fact that illegal drugs drive this massive culture of violence. And if we want to deal with gun violence, then let’s legalize illegal drugs.”[16]

    Comment by Ostap Bender — February 10, 2011 @ 9:35 pm

  14. Another issue is the fairness of the corporate tax. Why is it that Exxon pays less corporate tax ($0 per year, to be exact) than my near-by bakery? Either the off-shore and other loopholes must be closed, or they must be taxed in an alternative way, like an extra sales tax on their products sold here.

    Comment by Ostap Bender — February 10, 2011 @ 9:50 pm

  15. Exxon Mobil: $15.1 billion
    U.S. federal: -$156 million
    U.S. state and local: $110 million
    International: $15.2 billion

    Exxon paid the most taxes last year of any U.S. company, by far — but not a cent went to the IRS for income taxes. That’s because the oil giant does business in some of the mostly highly taxed countries in the world. Want to extract petroleum in Nigeria? Be prepared to fork over up to 85% of your profit in tax payments.

    Exxon doled out more than $15 billion in income tax payments to foreign countries last year. U.S. tax codes allow companies to take massive deductions in light of those international charges, which knocked Exxon’s federal income-tax bill down into negative territory.

    That said, Uncle Sam gets his money in other ways. Including sales taxes and duties, Exxon recorded $7.7 billion in U.S. tax costs last year, and paid even more overseas.

    Its grand total in global taxes for the year? A whopping $78.6 billion. The company’s effective income tax rate was a hefty 47%, its highest in three years.

    http://money.cnn.com/galleries/2010/news/1004/gallery.top_5_tax_bills/2.html

    Though Exxon’s financial statement’s don’t show any net income tax liability owed to Uncle Sam, a company spokesman insists that once its final tax bill is figured, Exxon will owe a “substantial 2009 tax liability.” How substantial? “That’s not something we’re required to disclose, nor do we.”

    http://www.forbes.com/2010/04/01/ge-exxon-walmart-business-washington-corporate-taxes_2.html

    The reason for this unfortunate situation is the fact that Exxon (as much as I dislike the company) operates in many areas that tax at a far higher rate than the US. Under current US law the company can offset this differential as a tax refund.

    Comment by Andrew — February 11, 2011 @ 4:58 am

  16. @ Andrew: “Exxon paid the most taxes last year of any U.S. company, by far — but not a cent went to the IRS for income taxes.

    So, Exxon’s tax payments went to foreign countries? Thank you, child, for unwittingly confirming my exact point: Exxon is listed as an “American” company and uses its profits to buy influence with US lawmakers. However, when it comes to paying taxes, Exxon uses off-shores to avoid paying US federal taxes. Instead, it pays taxes to other countries. But we, the American taxpayers, are expected to sacrifice our children and our incomes to fight wars – like the two Iraq wars – to defend Exxon’s interests.

    To repeat to Charles: one of the ways to reduce US deficit, is to close off-shore loopholes and to make corporations like Exxon pay their taxes in proportion to the revenue that they make here in USA. And Exxon is hardly unique: many other multi-nationals use the same off-shore tactics.

    Comment by Ostap Bender — February 11, 2011 @ 9:24 pm

  17. Ah Ostap, try learning to read you switch hitter, did you read the bit where it was pointed out that the final tax bill for 2009 has not been computed and that Exxon will owe a “substantial 2009 tax liability

    Of course not.

    In addition, 80% of Exxon’s profits are made in those foreign countries through the extraction of resources in those countries. It is quite normal to pay taxes to the locals in those cases.

    Unless you are Russian of course, in which case you just invade, kill the natives and then claim the area as an indivisible part of Russia…..

    Comment by Andrew — February 12, 2011 @ 11:22 am

  18. Oh and Ostap, you have never sacrificed anything in the service of the US, I bet you have in the service of Russia though…..

    Comment by Andrew — February 12, 2011 @ 11:24 am

  19. Oh I have done a lot of service to my country of USA. How much have YOU, Andrew, done in the service of the US? I bet that the answer is none. Your and your ilk’s in entire relation with USA is that of stealing $billions from the American taxpayers to pay for your russophobic agenda. What is even more amazing is that you take the American money and blood for given and you get very angry when somebody suggests that if you want money to fight Russia, you should hit your own government for it. You are a New Zealander living in Georgia and stealing money form your construction site employer. So, get New Zealand or Georgian civilians to pay for your warmongering. If that’s not enough – ask Australia and EU or anybody else. I hear China may want to fund anti-Russian projects….

    Just leave us, American taxpayers, out of it for the first time. We can’t afford to pay for your toys anymore. We now owe $14 trillion, and our annual deficit is around $1.4 trillion. Maybe it’s time New Zealand and EU gave foreign aid to us?

    Comment by Ostap Bender — February 13, 2011 @ 7:11 pm

  20. Corrected:

    Oh I have done a lot of service to my country of USA. How much have YOU, Andrew, done in the service of the US? I bet that the answer is none. Your and your ilk’s entire relation with USA is that of stealing $billions from the American taxpayers to pay for your russophobic agenda. What is even more amazing is that you take the American money and blood as a given and you get very angry when somebody suggests that if you want money to fight Russia, you should hit your own government for it. You are a New Zealander living in Georgia and stealing money form your construction site employer. So, get New Zealand or Georgian taxpayers to pay for your warmongering. If that’s not enough – ask Australia and EU or anybody else. I hear China may want to fund anti-Russian projects….

    Just leave us, American taxpayers, out of it for the first time. We can’t afford to pay for your toys anymore. We now owe $14 trillion, and our annual deficit is around $1.4 trillion. Maybe it’s time New Zealand and EU gave foreign aid to us?

    Comment by Ostap Bender — February 14, 2011 @ 1:31 am

  21. @Andrew: “Unless you are Russian of course, in which case you just invade, kill the natives and then claim the area as an indivisible part of Russia…..

    Andrew, it may surprise you to learn that the American continent didn’t always belong to the While Man. It used to belong to so-called “Indians” and “Native Americans”. Try to guess why they are called “Native Americans”. The white men fought them, spread deceases among them, expelled them from their lands, etc. As the result, the Indians lost 99% of their land to us, white people.

    Had the Russians done to Chechens in the 19th century what the Americans did to native Americans in the 19th century, Chechnya would have long disappeared and there would have been no need to fight the Chechen wars. The difference between Americans and Russians is that the Americans were always ruthless to native people, while Russians weren’t. Take, for example, your own Georgia which was a privileged nation in Russia and USSR:

    http://www.state.gov/r/pa/ei/bgn/5253.htm

    Official site of the US Department of State

    Several of the Soviet Union’s most notorious leaders in the 1920s and 1930s were Georgian, such as Joseph Stalin, Sergo Orjonikidze, and Lavrenti Beria.

    In the postwar period, Georgia was perceived as one of the wealthiest and most privileged of Soviet republics

    http://www.bmz.de/en/countries/partnercountries/georgien/index.html

    Official site of the Federal Ministry for Economic Cooperation, Germany

    Georgia

    Georgia used to be a comparatively wealthy Soviet republic. After the dissolution of the Soviet Union, however, consumer markets and the tourism sector collapsed and gross domestic product initially plummeted by 70 per cent.

    http://www.ceiig.ch/Report.html

    Independent International Fact-Finding Mission on the Conflict in Georgia

    Georgians were to some extent even a privileged nation within the Russian Empire.

    ////////////////////////////////////////

    Comment by Ostap Bender — February 14, 2011 @ 2:11 am

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