The death of the “punchbowl” metaphor

By J Saft
October 29, 2009

jamessaft1.jpg (James Saft is a Reuters columnist. The opinions expressed are his own)

Don’t expect the year-long rally in risky assets to be undermined any time soon by the Federal Reserve becoming concerned about inflation.

The old metaphor — that the Fed’s job is to take away the punchbowl just when the party starts getting good — just doesn’t apply in the current circumstances. That’s not to say inflation isn’t a threat in the medium term — it is virtually a promise.

But punchbowl thinking dates from a time when firstly the Fed was presumed to have a degree of control over events we now know is not true and secondly to an era when asset prices were the caboose rather than the engine of the economic train.

Even with an economy that is now growing, the risk of a self-reinforcing de-leveraging spiral is enough to ensure that the Fed will not pull the trigger on tightening any time soon.

“Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up, economies don’t do well, and when they go down, the economy can be horrid,” Pimco bond chief Bill Gross writes in his most recent letter to investors.

Gross argues that leverage inflated the price of assets even as investment in the U.S. real economy flagged. As this happened the U.S. economy became ever more dependent on asset prices and on the sectors, such as finance, which intermediated the borrowing. When the debt and asset bubble is pinched, the whole edifice is threatened, leading to a response like the one we’ve seen: massive and overwhelming aid trained on markets irrespective of the costs.

Pimco data shows that the prices of assets in the United States over the past 50 years have gone up 1.3 percent a year more than would have been expected given nominal growth in the economy, leading to a putative 100 percent overvaluation if you reason that the assets which depend on the economy for income shouldn’t outgrow it.

Unsurprisingly, the real outperformance of asset prices against economic growth has come in the past 30 years, since when debt growth has accelerated.

There are other explanations for why asset prices have outpaced economic growth. For one thing, off-shoring and outsourcing have both suppressed wages in the United States, leading to higher returns on capital, and increased the income that U.S. assets receive from overseas.

It’s obvious that the past 25 years have not been kind to labor, and as its share of GDP has declined the share going to asset owners has increased. In that sense increasing asset prices make economic sense, though there seems to be every chance that workers start to recapture some of what they have lost.


Taxes on capital and profits have also fallen in the United States, and, like wages, this is a trend that could easily be reversed in coming years, especially given the huge amount of public debt that will have to be paid back.

This brings us to the other very strong reason the Fed may have for not pulling away the punchbowl — or water bowl as perhaps we had better see it — even when the party turns inflationary: public debt.

Since the United States have taken a decision to not allow too much of the private debt to default, it has taken on a corresponding increase in public debt which will have to be repaid ultimately. U.S. debt as a percentage of GDP will exceed 60 percent, a level not seen since World War II.

But unlike the post-war period, Europe doesn’t need  rebuilding and though Asia will grow hugely those profits won’t flow to U.S. coffers.

So, if growth doesn’t allow the United States to repay debts, there are two options, neither pretty; default or inflation.

“No policymaker in the developed world — and, by now, few in the developing world — would want to countenance default as an option,” writes economist Spyros Andreopoulos of Morgan Stanley in London in a note to clients.

“This leaves inflation.”

To be sure, the Federal Reserve takes its mandate to control inflation and its independence seriously, but it is going to find itself in a very difficult squeeze, partly of its own making. The debt is high, growth will be poor and the time for private defaults is past. Threats to its independence will only grow.

Given that, and the dependence of the economy on asset prices, it’s not hard to bet that the evil we will be left with is inflation. Whether it is engineered or just kind of happens is less interesting than the reasonably high likelihood that it will happen at all.

For a time at least, that would argue that risky assets, particularly real assets and emerging markets, do well.

Longer term, things get stickier and stickier.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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Now the Fed’s job is to start paying people to drink from the punch bowl during the morning after the party. All of this in an efford to keep the unsustainable party going by keeping everyone in a drunken stupor.

Posted by josh | Report as abusive

This article is spot on target.
the conversion of private debt to public debt rescued those who deserved to suffer for their irresponsibility while putting that burden on everyone else. Now that public debt will do some combination of stifling growth and growing inflation. I doubt the administration is capable of managing it. The natural outcome will be some form of hyper-stagflation.
The question is how best to shield ourselves from the outcome of these reckless and irresponsible actions? Gold? Commodities? Move to China?

Posted by Taken Advantage Of | Report as abusive

Lets get this straight – The Fed lends our tax payer $$ to us to fund gov’t and then we pay them back with interest. Great deal. AMERICA WAKE UP!

Posted by Bob | Report as abusive

Hard assets…hmmmmm. It can’t included real estate yet, when projected devaluations for the next 12 months at 10-15%. China is going strong eating up all the commodities. Maybe that’s the place to be?

Posted by David55 | Report as abusive

If assets will go up due to inflation, then it is time to sit tight and wait it out. The over stretched and over extended people and businesses will slowly be choked out as it will take some time to turn around. I think we may see some more banks and insurance companies fail and even AIG may roll over if they cannot get their house in order.

Posted by f belz | Report as abusive

The federal reserve private central bank of is the single most corrupt and dangerous institution in America. Loathed by the great founding fathers of your nation as a greater threat to the principles of democracy than ANY standing army. They are now in a position to dominate American politics completely, look at Obamas staff appointments.. they’re ALL wall street bankers. Campaign financiers..

Posted by brian | Report as abusive

Our infrastructure can’t compete with an easy money charged financial services establishment and the excessively low interest rates that are inducing only investment banking bonuses will push more and more infrastructure and manufacturing jobs to China.

There is no small business investment as with zero percent interest, there is no reason to pay attention to the development end of the business cycle which is at the outside of the Risk/Yield Curve.

Playing the no interest game favors China’s development of infrastructure, not ours.

Wake up EASY BEN, that is why their is no domestic lending.

No one will invest in America’s Core when they need to make 20% every month in a paper trade.

The Feds answer to the Financial Crisis hangover is bankers doing scarface piles of cocaine with their coffee while innovators starve to death.

But there will be piles of cocaine at Goldman!

Posted by James Reginald Harris, Jr | Report as abusive

Looks like Mr. Sanft is announcing part 2 of the make belief economy, after spent next years income, comes devaluate(debauch) the currency till paying back the debts is painless. This after singing for years the mantra of inflation control and the benefits of monetary police.
In short what in other countries was not allowed by IMF, like massive subvention of failing private enterprise, is allowed the world’s only superpower (on borrowed funds) and in the end will have to be paid back the entire world holding Dollar assets.
Nice picture of the world to come.

Posted by John Hoever | Report as abusive

China’s economy is going strong right now, but there are still some problems here in China, such as inflation, policy and others. I admit that the crisis will not be
wiped off at short term and US goverment will try their best to make up the depression. :-)

Posted by jerry | Report as abusive

This is the first line from the objectives of the Peoples Republic Bank of China’s OBJECTIVES:

(‘It was noted at the meeting that efforts should be made to thoroughly implement the scientific outlook on development’)

I doubt Ben Bernanke or Timothy Geithner has mentioned SCIENCE one time. Certainly they have not done anything for a Scientist suffering under repeated massive infringments in their out of control banking system unregulated economy focused only on what can be taken and traded…not what could be built…

Do some more cocaine goldman, pretty soon, your jobs will be in China Too.

I sure as hell can’t survive in this environment.

Posted by James Reginald Harris, Jr | Report as abusive

Outstanding writing, James, as always.
However, for the engineering part of the affair, I would disagree, it matters, because the players are the same old clique that robs with impunity and stomps over their own people under the pretence of defending the american way of life. What way of life is that? In less than 200 years, they managed to deplete a virgin continent, and to shred the moral fabric of past and future generations.
When businesses do not work for people, then something is terrible wrong with the system. Quite cynical.

Posted by M | Report as abusive

The Congress has the right to buy back the Fed for certain millions dollars according to the Constitute. If memory serves, it’s like $450 Million dollars. Now the question is: who is the boss, the Obama administration or the Fed[a group of scumbags, financiers, wealthy families]? Obviously, you and I are still paying our hard working money, in terms of income taxes, to feed those never-full mouths. The boss is the Fed, in US.

Posted by WoW | Report as abusive

Since it was the greed of the investors that lead to this mess why not tax the heck out of them. They are the ones that drove prices up so they could have more of everything. If that sounds mean and unreasonable think of the poor folks that have to buy the overpriced trash the greed of the investors has for sale.

Posted by Sonny | Report as abusive

“But punchbowl thinking dates from a time when firstly the Fed was presumed to have a degree of control over events we now know is not true”…

James Saft…you either didn’t do your homework, or more likely you know exactly what’s going on and are PAID to con people away from the TRUTH: good job sir!

LOVE LIGHT TRUTH HONOR FREEDOM vs fear(hate) darkness lies hypocrisy control

Posted by GOD | Report as abusive

American businesses war against the American Worker has been quite a success. Only one unintended casualty, the golden goose (the American Consumer). Now your goose is cooked.

Posted by Tom Cook | Report as abusive

I just hope it is not a scenario where first it´s higher interest rates to keep attracting the capital inflows the U.S. economy needs to sustain itself and then higher interest rates to contain hyperinflation from all the money being pumped into the economy right now.

Posted by Sergio da Silva | Report as abusive

It’s the politicians who need to have their punchbowl taken away. A good dose of clean living would do them good.

Posted by Peter H | Report as abusive

Thanks M.

I heard Ron Paul debating with Michael Moore, two opposing agendas by two people who really love the people in their country with differing ideas about solutions. I think Michael does better with identifying social problems then he does with proposing ideas and Ron Paul has certainly identified the move to Corporatism.

We have a bad scenario and when we look at US leadership I like to look 50 years out. Certainly China does not have the technological, financial and engineering know how that we have the benefit of as a matured developed nation. However, our growing Corporatism has taken that advantage and degraded the individualist infrastructure that was traditionally rewarded in America. By absorbing the rewards of the system in order to artificially maintain performance by low interest rates which favor Corporatism over Entrepreneurial Capitalism we set in place a process where the demand for innovation is greater in the developing country. So much so that their banking policy includes strengthing the issues we as Americans assume we will always maintain our world leadership in Science and Engineering.

It was not to long ago that Sputnik was first in space.

As the results of the LHC at CERN start to come public in the next several years, we will see a rather profound hole in our Scientific knowledge. This will also create opportunities, business opportunities as we re-engineer computing and most everything we know about massive computation.

Thomas Edison would be treated poorly in today’s United States and if that does not change – our global leadership in Engineering, Science and Technology are in no way guaranteed.

While we are keeping our eye on the seconds, the ticks, so to say, our competition has their eye on the months and years. We see in China over 1 billion capable human beings with a massive ability and a growing economic force. 50 years from now, we might well be second or third place, which to all American’s is an uncomfortable thought, one we do not like to hear.

However, Corporatism, which is largely what has created our financial crisis is not the core efficiency that has made America great, it in itself a derivative product that has a tendancy to spontaneous decline.

As for Mike and Ron, I think they are both right, we need to give our country back to our people and no longer impede the progress of individuals by a corporatist philosophy that degrades US Leadership in the World.

As by all evidence, it has.

Posted by James Reginald Harris, Jr | Report as abusive

I forgot the source, but the saying was that money made out of money is meaningless for the society at large. While certainly not true, I think that for the keeper, money not spent is value lost.
Also, by far, the main contributing factor for elevating an economy is the technical progress.
Now, redirect all idling money towards research and development and so on, and theoretically we will get the best efficient dynamic cycle, i.e. non-chaos path growth. Is as simple as that, but with caveats.
We expect returns, don’t we? When, over short or long term? While waiting, we still want to leave our lives longer, healthier, and happier than past generations.
We are forced to make decisions. Even employing Pareto principality, there is nothing saying about optimal distribution of welfare. The only way to answer to these horrific choices is by debating ideologies. Only from there inwards, we can trickle down to basics.
As for inflation, quite simplistic, outspending on projects with no return by some aggregate capital conglomerates, mass infusion of fiat monies (printing) for saving all structures, very slow diffusion into neuronal economic network on demand side, inability to rise fast enough the supply side due to non-vendible inventories, and bingo, too much fiat monies in the system, and voile, patriotic requests for increasing savings, which will only conclude more inefficient use of resources. This is because the distribution of the newly printed money was skewed towards the same structures that misused the bulk of liquid capital in the first place. In fact, over time, all taxpayers pay back what was wasted by the few. The positive, however, is that some moderate inflation over no more than two to three years in a row is supposed to incense supply. What we are covering now is the surge in oil prices, two wars with no economic gains, and over consumption based on unwarranted borrowed money.
Are we guilty collectively? I suppose so. We are guilty of neglecting our own interests and bowing to the special interests of a few. Democracy is giving us the tools, but we should learn to use them. Economics is far from being a branch of science. It is art, and it ain’t pretty.

Posted by M | Report as abusive

Good article, it links and explains difficult concepts.

Brian, Federal Reserves are simply ‘hubs’ to other countries, like private sector banks, they have transactional banking, assets and liabilities, treasuries, insurance/guarantees and Special/Project Finance.

Also, for the Rest of the World’s sake, I am very happy with somebody financing an advertising campaign, and the latest outcome, surely there’s some Register of Interests ? It also creates jobs and transfers knowledge and skills to the public sector.

Posted by Casper | Report as abusive

I always enjoy your articles. And I think what you are saying is that the US cannot maintain that just because it “paid too much for that muffler” the economy that sold that muffler is therefor wealthy.

Assets in this country – especially commercial buildings- are notoriously impermanent. They are generally designed to last the life of their mortgages and than to be resold and rebuilt or demolished to be replaced by another impermanent structure. Those structures are also depreciated more quickly than the term of the mortgage and that usually means they are sold before the mortgage is ever completely amortized. Other than the site – which itself is prone to the loss of value if the location is no longer good for business, there is nothing but junk sitting on that site. and it is an expense to dispose of those millions of tons of rubbish – almost nothing of which has any value except for some recycled materials (another fluctuating value).

In the modern economy we cannot total our asset value the way people historically assessed their wealth. They would total up the value of everything in the building includng the fixtures, the furniture, the linens and even the bed pans. Today most of the contents have little value once they have left the store. That also applies to jewelry. A computer system has a useful life of a few years before it is fit only for the dump. You can’t even give them away. The manufacturers would love a world where everyone was obligated to replace them every year. Consumer goods are really only excuses to spend money and their value is almost nonexistant as second hand – every garage sale proves that point.

Tangible assets, especially commercial property and apartment houses, are only as valuable as their ability to generate an income.

Posted by paul rosa | Report as abusive

But the real cause,namely,Derivatives Trading,in which at least $600 trillion,is circulating,continues….Without banning this,no solution can be found.

Posted by Sadasivan | Report as abusive

Many of our leaders (especially on the right), like to extol the virtues of living a moral life based on Christian values. But these same people also moved to bail out the banks and put their constituents on the hook for generations to come.

So what would Jesus REALLY do?

(95) Jesus said, “If you have money, do not lend it at interest, but give it to one from whom you will not get it back.”

(Gospel of Thomas) Thomas O. Lambdin translation.

We are not animals. And we should not be content to live as such.

Posted by Benny Acosta | Report as abusive