James Pethokoukis

Politics and policy from inside Washington

On gold and asset bubbles and inflation

Nov 17, 2009 18:56 UTC

The great David Goldman. First on the US asset bubble:

BOTH bond and stock prices are driven by the dollar. 17.5% unemployment by the broad measure keeps wages down and keeps the CPI low, despite the surge in commodity prices, while the cheap dollar makes US assets a bargain. Well, not exactly: the enormous reserve growth on the part of Asian central banks means that the Treasury’s debt-buying program has been outsourced to America’s Asian trading partners! No-one dares pop the bubble. It’s like what Woody Allen said about death. He wasn’t afraid of it; he just didn’t want to be there when it happened.

Now on gold:

What’s the price of the last ticket on last train out of Paris on the night the Germans march in? Whoever is carrying the most cash will get it, and that will be the price.  … As I have tried to show in several recent articles, most recently this Sept. 15 essay at Asia Times, gold is a hedge against the collapse of America’s central role in world affairs.

What is the correct price? Central banks alone own about 4.8 million tons of gold. The world produces about 2,200 tons. Suppose that central banks wished to increase their gold holdings by 1 percent. That’s 48,000 tons or so, or more than 20 times annual mining production. What’s the price elasicity on that sort of thing?  How badly do you need that ticket out of Paris? … If the whole world, including the Asian central banks, man the bucket brigade–except with kerosene in the buckets rather water–the prices of real assets are going to rise. The best real assets to hold are the ones most sensitive to the degradation of the dollar.

Remember the Misery Index?

Nov 9, 2009 19:13 UTC

I am not sure Jon Hilsenrath of the WSJ does: “It’s hard to get inflation when unemployment is so high.”

Just go back to the 1970s, my friend. How about 1975 when we had roughly 9 percent inflation and 9 percent inflation and 8.5 percent unemployment? There’s your Misery Index. Actually, the rest of the article is quite good, focusing on how banks are buying treasuries rather than lending.

COMMENT

Hilsenrath is about 25, right? Of course he doesn’t remember.

Posted by David | Report as abusive

Obamanomics, Big Government, inflation and the price of gold

Nov 5, 2009 14:43 UTC

Ed Yardeni says the rising price of gold is sending a message about the political economy:

Yesterday, I observed that gold tends to be a hedge against reckless governments as measured by their widening deficits and mounting debts. It is also a hedge against governments that either cause or enable inflation to rise. It is interesting to note that:
(1) The price of gold soared from a cyclical low of $104 on August 31, 1976 to a high of $737.5 on January 22, 1980. President Gerald Ford left office in January 1977, near the low for gold. Jimmy Carter was President from 1977 to 1981, when gold soared.
(2) By the time Ronald Reagan left the White House in January 1989, the price of gold was down to $408.3. It fell to $330.9 when George H. W. Bush left Washington.
(3) It continued to drop during Bill Clinton’s two terms, and actually bottomed almost the day George W. Bush moved into the White House.
(4) From then on it was mostly straight up with a brief drop late last year.

Draw your own conclusions, or else, let gold be your guide. Confidence in currencies in general, and the dollar, in particular, was lowest during the Carter and Bush Jr. years, and the first 10 months of the Obama Administration. Confidence was highest during the Reagan, Bush Sr., and Clinton years, when the federal deficit was shrinking and turned into a surplus. During those years, the US government was mostly pro-business, and the public was mostly pleased with the government’s economic policies.

COMMENT

Gold is only one signal among many that informs economic policymakers. When the economy is performing significantly below capacity, when unemployment levels are uncomfortably high and expected to remain so, when the spectre of deflation remains a possibility however slight, why do some OBSESS over the price of gold? The nascent recovery in the economy looks quite fragile thus far, so why take any chance at all of further impeding that recovery by defending the dollar now or reducing deficits now on the altar of blind homage to gold? Yes, gold may well be signaling problems in the future. But we have to survive the present before we even get to that future. So screw gold, let’s get back on the path to sustainable economic growth. Then we’ll be strong enough to respond to what gold may be telling us.

Posted by Bill, Fairfax, VA | Report as abusive

Barney Frank’s wrongheaded assault on the Fed

Nov 3, 2009 18:20 UTC

When you’re a nation getting ready to borrow $10 trillion or more over the next decade, you don’t want markets questioning your central bank’s commitment to controlling inflation.

But Congress continues to risk just such a scenario, whether through aggressively questioning Federal Reserve Chairman Ben Bernanke or pushing a bill to audit Fed monetary policy.

Now Representative Barney Frank, the chairman of the House Financial Services Committee, has suggested curbing the authority of the 12 Fed regional bank presidents.

As Frank sees things, monetary policy should not be influenced by “inappropriately placed private businessmen — or women, occasionally — picked by other private businessmen, and occasionally women.”

Drill down a bit and it’s clear that what really bugs Frank is not so much that regional bank presidents are selected by a nine-person panel, six of whom are elected by bankers. He just thinks they’re too hawkish.

Frank even commissioned and publicized a study that found that 97 percent of the hawkish dissents at Federal Open Market Committee meetings during the past decade were from the regional bank presidents.

Of course, higher rates would have been a good thing, given that the Fed’s extraordinarily easy monetary policy was a huge contributor to the financial crisis. And going forward, the Fed will face the economically and politically challenging task of withdrawing monetary stimulus when economic growth may well be sluggish and unemployment high.

But such medicine may be necessary to prevent an inflation outbreak. Congressional threats and bullying will make a hard job even more arduous.

Moreover, one reason the Fed has a decentralized structure is because of historic concerns about monetary policy serving only Washington and Wall Street.

Yet citizen concerns about the concentration of financial power are as alive today as they were in 1913 at the Fed’s creation. Monetary policy set solely by a presidentially-appointed and Senate-confirmed Board of Governors should certainly set off alarm bells with bond vigilantes concerned that Washington may try to inflate its way out of its debt problems.

If Congress wants to look at how the Fed conducts its  business, better to focus on better ways to make monetary policy reflect forward-looking market gauges such as commodity prices rather than the unemployment rate or output.

Ultimately, though, the Fed’s problem isn’t too much influence from bankers in Kansas City or Atlanta or Chicago. It’s too much influence from politicians in Washington.

COMMENT

The Federal Reserve & its system of usury is the greatest scam in world financial history & I can’t understand why highly educated people & economists fail to see the bare truth for what it is. As an irony, not too far into the future, the common masses may well become more aware of what the Fed truly stands for, while educated MBAs continue to argue in vain.

Posted by Mike | Report as abusive

Barney Frank: Let’s pack the Fed with doves

Oct 30, 2009 14:26 UTC

Here is Barney Frank at yesterday’s House Financial Services hearing:

I had a study done. Ninety percent of Federal Open Market Committee [dissents] are from regional bank presidents and 90 percent of the 90 percent are for higher interest rates.

Those are inappropriately placed private businessmen, or women, occasionally, picked by other private businessmen, and occasionally women, and they should not be setting public policy.

I don’t care that the Fed rejected what the Treasury said. That may be a nice discussion among gentlemen. The Fed will not reject it when we, I promise you, next year, take up legislatively the issue. And I think it’s very clear. You should not have private citizens like the presidents of the regional banks voting on policy. And I guarantee that will happen.

Me: Along with the Fed audit bill, it is clear Congress wants to have more influence over the Fed. This, right at the time when global financial markets will have to remain confident America will not inflate its way out of its debt.

COMMENT

The current fiat U.S. Dollar is not constitutional. I don’t know what U.S. Constitution most people read, but mine says that only gold and silver are legal tender. The history of the Continental Dollar was the reason for this little inclusion to the document.

IMO the markets should be shorting the fiat U.S. Dollar and U.S. Treasuries to punish the current crop of prodigal politicians in the D.C. swamp.

Posted by Austrian School | Report as abusive

Oil prices, inflation and a double-dip recession

Oct 26, 2009 14:24 UTC

Andy Xie paints a dire scenario:

Central banks around the world have released massive amounts of money in response to the current financial crisis … But the proposition that a weak economy means low inflation is false. The stagflation of the 1970s proves it.

This round of monetary growth has mainly fed speculation, not credit demand for consumption or investment. Speculation has reached a dangerous point with the oil price threatening to reach triple digits again. Its implications for inflation may spook the central banks to raise interest rates quickly and trigger another crash.The excess money supply has created a new liquidity bubble.

The resulting asset inflation (stocks and bonds in developed markets and everything in emerging markets) has stabilised the global economy. The current equilibrium is one on a pinhead. The hope for strong economic recovery led by emerging economies raises investor optimism – and asset prices. This eases pressure on corporate balance sheets, spurs property production and boosts consumption through the wealth effect, making the hope self-fulfilling in the short term.

A rising oil price threatens to derail this recovery. It can trigger a surge in inflation expectation and a major crash of bond markets. The resulting high bond yields may force the central banks to raise interest rates to cool inflation fears. Another major downturn in asset prices would reignite fears about the balance sheets of global financial institutions, leading to new chaos.

The bull case on the dollar

Oct 13, 2009 11:30 UTC

Scott Grannis, the Calafia Pundit, plots a currency course that does’t turn America into a third-world economy:

Modestly good news, such as an early move by the Fed to raise interest rates even by a little bit, or news which shows the economy is likely to simply avoid a double-dip recession, or news which indicates just the tiniest rightward shift in fiscal policy, might be enough to push the dollar higher.

It’s hard to fight the tape on this, but I continue to believe that the long-run prospects for the dollar are favorable. I think the economy is doing better than most give it credit for, I think the Fed is going to move sooner than most expect, and I think that policies in Washington are going to turn out to be less awful than the market fears. I’m not saying that everything is going to turn rosy, merely that I don’t see things getting worse forever.

Me: Maybe, but this sounds like a 2011 story, not 2009 or 2010.

COMMENT

I disagree, 2011 may be the point the dollar begins to bottom out but not look to a bullish run – interest rates will be just high enough by then to continue unhindered to borrow the vast sums needed to repay the Chinese.

But I can see U/E coupled with underemployment maxxed at 20% through 2011. Greatest fear – rates have to be ratcheted soo high to get investors attention. No “U”, “V” or “W” – this will look like a nasty “L”.

The world has talked about the uncoupling for years, looks like that will include debt. The US will not appreciate the end result. We could barely take 6 months of $4/gal gas; can we stomach an astronomical interest repayment?

Posted by Hank Rearden | Report as abusive

How to get a strong dollar

Oct 8, 2009 16:56 UTC

The enlightening David Malpass in the WSJ:

Measured in euros (a more stable ruler than the ever-weakening dollar), U.S. real per capita GDP is down 25% since 2000, while Germany’s is up 4% and tops ours. The solution is a strong U.S. jobs and wealth program. It has to include stable money, a flatter, more competitive tax structure, spending restraint, and common-sense bank regulation so small business lending can restart. Treasury has to rapidly lengthen the maturity of the national debt and take steps to protect the Fed from market losses on its long-term debt holdings.

Me: Absolutely. Don’t worry about the dollar per se, just put in place policies that keep inflation low and productivity high. While Team Obama likes the weak dollar (though Congress is getting worried), the chances of a sharp dollar tumble are rising and will force it to reduce the deficit soon than it would prefer.

More on the erosion of dollar dominance

Oct 7, 2009 13:44 UTC

Justin Fox of Time echoes my thoughts on the dollar, that its currency dominance has enabled massive deficit spending by the United States:

The U.S. economy’s share of global economic output has been declining and will almost certainly continue to decline as formerly poor countries get richer. With that, the dollar’s role will need to change.

Such a change wouldn’t be unmitigated bad news for Americans. As I’ve written before, having the dollar as the world’s currency has been a mixed blessing. The dollar’s global role inflates its value, for example, which makes imports cheaper for consumers here but also makes U.S products less competitive globally. Dollar supremacy also allows the U.S. government (and until recently the private sector) to get away with wildly unbalanced budgets without paying an immediate penalty in higher interest rates, which can be nice for a while but tends to end in trouble. The global capital-flow imbalances that many economists now say were at the root of the financial crisis are in significant part a product of the dollar’s outsized role.

All of this means that it may well be in the long-run best interest of the U.S. to push for an orderly transition away from the current dollar-based global monetary system and toward one built around currency baskets, the International Monetary Fund’s special drawing rights, the bancor, gold or whatever other measure of value we can all agree on. In other words, it’s not the worst news in the world that the Persian Gulf countries are talking about moving away from the dollar. Even if they say they aren’t.

Me: Again, keep inflation low, productivity high and deficits narrow — and let the dollar worry about itself. How am I wrong on this? And Simon Johnson explains why the White House likes the current dollar decline — as long as inflation stays low:

This may, of course, turn out to be a miscalculation, but think what a weaker dollar does for the industrial heartland, where so many congressional seats will be in play and where today it’s easier to export or compete against imports because the same dollar costs convert into fewer euros, yen, or renminbi (this is what a “weaker” dollar means—foreigners can more easily afford our goods and their stuff is more expensive to us). If the dollar stays weak or declines further, our car companies, machinery makers, and turbine blade manufacturers will soon be rehiring and we’ll finally get some job growth as part of our sputtering economic recovery.

COMMENT

Sure, we’ve mis-used the opportunity of the dollar being a reserve currency. Instead of investing in our future and saving as a country, we spent, spent, spent.

Trying to find a silver lining to a long-term decline in the Dollar is a bit premature though. Our economy – heavy reliance on imported goods, weak manufacturing base, high reliance on foreign oil, and huge budget deficits to fund – would leave us overly-exposed to a rapid Dollar decline. You want to experience $150 oil again? How about hyper-inflation in all the wrong places – food, industrial imputs like copper, and stagnation in wages for the vast majority of the economy. Oh, and a spike in interest rates to 6, 7, 8+ – what does that do to our interest burdens as families and governments (state and local). It could all create an accelerating feedback loop to the downside.

We should be preparing for the inevitable shift away from the Dollar as a reserve – but we’re not…

Posted by traderjoe10 | Report as abusive

Inflate away the debt? Yes, that is a stupid idea …

Sep 11, 2009 14:53 UTC

As Bruce Bartlett correct observes:

Although it is thought that inflation is an effective way of
reducing the burden of debt, this is no longer true. For one thing, a
declining portion of the debt is financed with long-term securities.
Today, just 3% of the debt consists of bonds with maturities of 20
years or more; 10 years ago, the proportion was four times greater. To
the extent that the debt consists of short-term securities that must
constantly be rolled over, inflation does nothing to erode its value
because interest rates just rise to compensate, raising interest
payments and borrowing, thus maintaining the real value of the debt.

Inflation
will also cause the dollar to fall on international markets, which will
cause foreigners to dump their bonds. With foreigners now owning more
than 50% of the privately held debt, this may force the Treasury to
issue foreign currency denominated bonds. At this point, our finances
will effectively be controlled by foreigners and the International
Monetary Fund (IMF), just like Third World countries.

No one knows the point at which debt becomes unsustainable. According to an IMF report,
the critical point is when a government is borrowing just to pay
interest on the debt. According to the CBO, we will reach that point in
2019 when the federal government is expected to borrow $722 billion and
its net interest expense will also be $722 billion.

COMMENT

Thanks! That’s a sobering new perspective. Of course, one should never play cards with a magician…

Posted by Pete Cann | Report as abusive
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