TCS Daily


Addicted to Easy Money?

By Larry Kudlow - November 11, 2009 12:00 AM

In an interview with CNBC's Maria Bartiromo yesterday, Richmond Fed president Jeffrey Lacker refused to offer any clear sign as to when the central bank might finally end its zero-bound policy and begin raising rates. When asked whether he was worried about future inflation, Lacker said he thinks "we're in a good place with inflation right now." And when asked whether the U.S. would move to lift rates in 2010, he said, "It could take longer than that."

Look, I would have asked Lacker if the Fed will tighten policy in my lifetime. He wouldn't even commit to 2010.

Meanwhile, Lacker never once mentioned the dollar, which continues its decline virtually on a daily basis. Nor did he mention record gold prices. Nor did he mention rising commodity prices, including oil. Even the Treasury bond-market TIPS inflation spread has moved from zero to 220 basis points this year.

Lacker instead seems to be focused exclusively on GDP. But GDP is a lagging indicator. Lacker and Fed policymakers should be focusing on forward-looking leading indicators, like inflation-sensitive market prices.

Unfortunately, all of this sounds eerily familiar to the Fed's big mistake seven years ago — the one that unleashed an inflationary bubble that eventually destroyed the economy.

Here's something worth considering: What happens if the economy recovers faster and sooner than the Fed thinks? What happens if the unemployment rate comes down faster and sooner than the Fed thinks? If the Fed suddenly turns the spigot off because the economy is more V-shaped — raising rates and withdrawing cash — the stock market may very well get walloped.

Or what if the dollar- and gold-market vigilantes force the Fed to take action? Bernanke & Co. cannot ignore the currency- and gold-market rebellion forever.

What's the bottom line here? If you use the wrong model of inflation as your guide, you're going to get the wrong results.


This article first appeared on Kudlow's Money Politic$.
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40 Comments

That's because Larry, you completely miss the REAL issue
What is REALLY going on? Same thing that happened in Zimbabwe: The President fired or threatened to fire his central bank chiefs if they didn't print money faster than Nigerians can send out scam spams.

And Bernanke decided to keep his job. So, he sucked AND swallowed.

And that's it, folks! Simple as that. Occam would be proud.
http://en.wikipedia.org/wiki/Occam%27s_razor

"world gold supply runs out"
http://www.telegraph.co.uk/finance/newsbysector/industry/mining/6546579/Barrick-shuts-hedge-book-as-world-gold-supply-runs-out.html

This is a question I have asked before in discussing the use of gold as money.
If nothing else is used to augment gold for money, the purchasing power of a unit of gold must increase. Which some call 'deflation'.
And what is wrong with that? Nothing as far as I can see.

Easy money under inflation and easy money with deflation...
During Stagflation the monetary authorities tried to stimulate the economy with easy money at high bank interest rates. That was inflationary. But they assumed we were still Keynesian and it would all work itself out with expansion. This didn't happen because were already post-Keynesian as of 1970. Not until 1982 when President Reagan crushed inflation and initiated our Supply Side practice of capitalism did we recover to a sustained expansion over 3% again...until 2008.

Easy money policies with low bank interest rates are reflections of a deflation here in America such as the Japanese economy has been trapped in since 1992 with 1% GDP expansion. The economy does not grow in spite of that cheap money because the investment opportunities for capitalists cannot be justified in an economy that is mature, with consumer markets that are saturated.

We don't have much inflation here in America and the US dollar is about flat as the global standard of value. Other currencies are strengthening against the dollar as their rapidly growing economies are still Keynesian and inflationary and their authorities must lay off some of that inflation into their exchange rates.

Gold is being speculated up and sucking real value out of the economic system that might otherwise be invested as working capital because people don't understand global financial capitalism and hedge against a dollar that is actually not suffering inflation. Oil is moving back up as OPEC understands one year later that the damage has already been done and they are now leaving real money (and good dollars) on the table. The bankers are taking as much as they can again. Health care goods and service prices are continuing to climb as those players recognize that their particular extortion must soon come to an end. Even the universities are demanding higher tuitions as long as we will continue to be exploited by them. (Not-for-profits institutions of higher learning, holding a sacred public trust...sure they are.) And we are all waiting for the Chinese to revalue the renminbi and start taking a larger share for themselves of virtually everything we buy.

Our political leaders are throwing mountains of money at these problems because they literally do not know what else to do. And they admit it. They are flat out of bright ideas about how to improve the US economy. They hope someone figures this out soon, of course, and they are buying themselves time. But time and money are two things that we are rapidly running out of.

The dollar IS inflating because the gold markets SAY it is
And that is all there is to it. Gold is a leading indicator to inflation that never has failed in that role. Men's tailored suits, for example, are a lagging indicator.

Think of a puddle of gasoline sitting in front of your house. Then think of some idiot named Bernanke pouring more gasoline so that it totally surrounds your house about three inches deep.

All it takes in either case to light it up is a single match. That is called 'monetary velocity' and that is all the current expansion of money supply needs for hyperinflation to jump start and do so very quickly.

The gold markets are just very able at detecting gasoline fumes and are thus way more sensitive to what is going on -- like canaries in the coal mine.

Gold is not being 'speculated' upon. It is the dollar that is...speculated DOWNWARD, or 'shorted' if you will. The amount of gold is pretty much constant (with about 2% increase in global supply per annum). It is the demand for dollars vs gold that is going down the toilet.

"Our political leaders are throwing mountains of money at these problems because they literally do not know what else to do"

Correction: The ones IN POWER don't know what to do. There are plenty of alternative leaders who do know what to do.

"They hope someone figures this out soon, of course..."

No they don't. Or rather, they hope the public doesn't catch on (TOO LATE!) that there are others to take chances with who might do a better job. They would rather rule in hell than be out of power in heaven. It worked for FDR and his cronies in the 1930s, after all.

"But time and money are two things that we are rapidly running out of."

Nope. They can make all the money they want...and ARE doing so. As for time, that is dictated by how fast the public wises up or not.

Gold is not money...
Gold is an idle store of wealth. It's nominal value goes up and down much faster than any underlying inflation could account for. An equal number of people exchange it for fiat currency...as those who buy it with fiat currency. It has a market price. People purchase gold to hedge inflation that might not really be there and to speculate. If we did have inflation then bank interest rates would reflect that. Net present value calculations guarantee that we are actually in a deflationary stasis here in America just as they have been in Japan since 1992. Interest rates don't lie. The dollar is strong.

If the euro is strong against the dollar then the European economies continue to show manufacturing strength with some domestic inflation of their own to be laid off into their exports...to us. This does not mean the US dollar is weak. It is about flat insofar as we have very little inflation. The factors of production that you can purchase over here...material, labor and overhead such as commercial real estate...those prices have not moved higher. In fact, they have stayed about even or have moved down.

Gold has nothing to do with this because gold is not legal tender. You just like to think that it is.

Money is whatever you want it to be.
There was a guy who used to, and may still, create very ornate bills, pieces of art really. He would ask store owners if they would take that in trade.
Money was used before governments therefore governments are not required to 'create' money.

it does not go up and down. The dollar price goes up and down.
The amount of gold is constant.

You don't get it. This isn't about gold. It's about the dollar. The gold markets only provide a barometer to what the dollar is or isn't worth relative to said barometer.

"If we did have inflation then bank interest rates would reflect that."

No, you wouldn't. And gold is a LEADING indicator. It shows devaluation that is coming. Not inflation that is here and caused by said devaluation.

"The dollar is strong."

Hahahaha...compared to WHAT? Other worthless fiat currencies?

"Gold has nothing to do with this because gold is not legal tender. You just like to think that it is. "

One, did I say it was legal tender? No. You know why I didn't bring that issue up one way or another? Because it has NOTHING to do with the topic at hand.

Like I've told you before, Forest -- whatever you paid for your Wharton School of Business education was a real waste of money. You should sue.

The amount of gold is not constant.
There is fixed amount of gold on the planet. Has all the gold been found and recovered? I don't think so. Chile just announced increased gold production.
I support the use of free market money based upon assets. Gold is a good as silver, platinum, rhodium, etc.

I agree with all of your post except where noted.

not Keynsian?
If you say that the US does not have a Keynsian system, in spite of the evidence that it does what keynsianism advocates, then what would you call it?

not much inflation?
You say there is not much inflation, and that the dollar is strong.
Okay, you don't want to compare it to gold, or other currencies, or anythinbg apparently. This line of thought would get you off the hook of accounting for its fall, and rendering any discussion of it meaningless.

You also said that some other currencies were strong now BECAUSE they have more inflation than the US. If they had more inflation they would be weaker in comparison, not stronger.

What school of economics do you subscribe to?

That was a slip-up from my Teacher (Zyndryl), I am sure
I am sure what he meant by "The amount of gold is constant" is that the amount (and purity) of Gold one can get for a dollar note is (or wiil be or should be) constant in a Gold Standard system.

Ohforchrisakes...
Zyndryl,

You said "worthless fiat currencies"

Nevertheless, my friend you use that fiat currency every day. You are paid for your time and anything else you sell here in the United States with US dollars. You hold onto those dollars as a store of wealth and buying power. You exchange your currency for other assets and resources, goods and services. Worthless indeed. You would reach down and pick a $20 off the sidewalk in a NY minute.

Gold, for its part, is an idle store of wealth that does not produce income while it is sitting in your vault and that might or might not even retain its worth from day to day...relative to the real standard of value, the US dollar, against which everything else on this entire Earth is measured. If our inflation is modest...and it is...then the dollar is essentially flat. All other currencies and such precious metals as gold move up an down in relation to that nominal metric.

Your confusion here is very natural because your understanding is completely intuitive. However, when people believed that the Earth was the center of the Universe then it seemed completely reasonable that the Sun revolved around us. Made perfect sense to everyone and that too was just completely wrong.

Good...
When the euro, for example, undergoes inflation because the underlying value of European income producing assets and resources...raw materials, direct labor and factory floor...are bid up in nominal euro denomination by capitalists one way for European manufacturers (exporting their products) to increase their revenues is for the euro itself to strengthen against the dollar. In this way their dollar denominated contracts deliver more euros and their euro denominated contracts are worth more dollars...the standard of value in the global economy. The dollar has not weakened if we have little inflation. It only seems that way. Actually, the euro has strengthened and those assets in Europe really are worth more. This is healthy Keynesian inflation that always occurs in a rapidly developing manufacturing economy.

However, such domestic inflation is hard on working people holding cash because their buying power erodes. Further, bank interest rates are burdensome for people who are not putting the money they borrow to work. Again, the labor force who must consume most of what they earn. Therefore, the monetary authorities can take some of the pressure off their own economy by exporting some of that inflation through a strengthened currency as long as this effective increase in prices to export customers does not impact unit sales enough to slow the economy too much.

Eventually, China must strengthen the renminbi. When they do our dollarized prices will go up for everything we import from them. This will be inflationary for us. However, Europe has been doing that same thing to us for this entire decade and we have not had much inflation here because it served to balance our underlying deflationary pressures as we shift more of our manufacturing tasks off shore and import more of what we consume here.

The Japanese economy has suffered with a deflationary recession since 1992 in large part because they do not have the same strong consumer demand for imports from nations whose currencies have strengthened against the yen...exporting inflation into Japan to balance their deflation.

As China starts correcting their currency upward they will be laying off some of their inflation and they will be extracting more of our GDP each year just as OPEC has finally figured out how to do in spite of NYMEX. Along with the health care industry, the banks and the universities. If this economy does not start growing rapidly from the bottom up now that our top-down, Supply Side capitalism has matured into economic stasis then the socialism we are undertaking will be too expensive to sustain into perpetuity. Socialism is expensive. Strong central governments spend a lot of money.

It took the Soviet Union 45 years from 1946 to 1991 to fail because their economy could simply not create enough wealth for the Russians to stay in the game of military hegemony without an imperialistic payday and while bearing the burdens of socialism. The United States also does not liquidate its conquests to treasure and captive populations. That game has been over for 100 years, actually. But we continue to spend like we are marching out on great adventures. And now we really have come to expect the Commander in Chief to take care of us as his loyal soldiers. That war ended in 1991. We need to demobilize and once more take care of our personal affairs.

This is America and we are Americans. If those of us who were born here are confused about which of us dropped the ball then you can be certain that the people who immigrate here will pick it up and run with it.

not good ForestB
Well it is good that you've now admitted that the US uses the discredited Keynsian economics.

And it's good that you've told us that countries can 'muddle through' for years even with bad economic policies, something everybody knows.

But it's bad that you haven't answered my question about what specific economic school of thought you yourself subscribe to. Don't be like Roy who kept trying to dodge the issue.

re; Christ's sake
It can't be right when you say gold is 'an idle store of wealth'. If a currency, rather than being of the fiat kind, is rather based on gold, then it is just as active as anything else. One can, borrow, lend, mortage, invest, etc.

Every lame old excuse against gold has been discredited ages ago; whether it's idle, not enough of it, too heavy, not practicle, etc.

ITMT, why is it that politicians hate gold standards, but just LOVE fiat currencies?

Forest and 'little' inflation
If there has been only 'a little' inflation, as you maintain, please do the math for us and tell us how many dollars it would cost to say; build another Hoover Dam, another exact copy of the Empire State Building, or Paul Allen's super yacht today. Then compare to how many those items actually cost at the time.

As another example; apparently it cost about an once of gold(in the dollars of the time) at the turn of the century(20th), to buy a decent suit in NYC. Nowadays it also cost about an once of gold, in current dollars to buy a suit of the same quality. What kept or lost its value?

gold running out
It doesn't run out in absolute terms, nor is it a problem if productivity increases. When things cost less, you're right, it's good.
All this has been worked out ages ago by the school of Austrian Economics.

gold running out
It doesn't run out in absolute terms, nor is it a problem if productivity increases. When things cost less, you're right, it's good.
All this has been worked out ages ago by the school of Austrian Economics.

Free market money can't be controlled by the state.
That's why they love fiat currency.

More economists need to take thermodynamics courses and physics.

Fiat currency provides an illusion of control. Like the commercial used to say, "You can't fool mother nature."

All one has to do is ask why a dollar today is not worth the same as it was 100 years ago. Given the improvements in productivity and efficiencies, the dollar should be worth much more than it is.

Did they print more Euros?
"the essence of inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services."

http://mises.org/story/908

The challenge the government has with fiat currency is to keep the money supply stable...but stable compared to what?

to Marjon re compared to what
They're happy as long as it's stable compared to say....Weimar and Zimbabwe.

There's simply not enough gold...the global economy is too large for a Gold Standard...
After Bretton Woods in 1944 the global economy was tied to a fictional Gold Standard through the US dollar. By 1971 the United States was clearly at risk of default regarding the redemption of dollars for bullion by foreign banks. The Gold Standard was abandoned in 1972.

Gold continues in its role as a store of wealth but it is not income-producing per se, while dollars may be exchanged for interest bearing Treasury Debt instruments. The rate of interest covers dollar inflation.

If you want to replace the dollar then you must come up with a currency that would be superior. Until then, such a transition simply cannot happen. We moved away from gold because it could not carry the burden of financial capitalism. There is no going back to that.

Why must there be a gold 'standard'?
The only government involvement in a gold 'standard' should be to ensure the purity and mass of each gold piece.
Deciding its value is up to the market.

Why should 'money' be considered wealth at all?
Money is just a convenient method for trade.
Wealth is not money and using money for 'wealth' inhibits real wealth creation.
Historically, people like the Jews who were kicked about accumulated wealth in themselves and diamonds, easy to pack up an leave when some tyrant wanted to kill you.
I think many Chinese have these same attributes for similar reasons. Hence the desire for higher education among Chinese, too.
Fiat money in a bank or in T-bills are illusions of wealth the governments can manipulate.

Is gold going to be an idle store of wealth or is gold going to be money again...
Marjon,

You said "Deciding its value is up to the market."

That implies a price, denominated in a currency that is not gold. These guys are talking about no such "fiat currency" at all as legal tender. But only specie gold itself or privately issued bank notes backed by vault gold and without the involvement of any government agency. If the bank did not actually have the gold, however, its notes would collapse, the bank would fail and anyone long on such money, deposits at the bank, bank equity or the bank's debt instruments would simply lose everthing...while the bankers might run away.

The financial market could correct itself in this Darwinian manner but the bankers would always be watching for their best opportunity to grab everything they could carry and skip town.

Furthermore, when transactions occurred beyond the reach of any such bank the medium of exchange would, indeed, be gold coins and bullion instead of electronic account balances. Very difficult. Any economy operating like that in the global arena would mostly be ignored by the rest of the world. There's simply not enough gold and transporting it around is extraordinarily disruptive. Not going to happen.

Egold
Why must any currency denomination be used?

What is wrong with mass? That is how such denomination are determined in the first place. Eliminate that step and use the mass.

I wonder how Swiss banks could have stayed in business for so long without running away their depositors money?

If banks and businesses want to make trade easier and most efficient they must have trust with their customers. Such trust can be established by independent auditors and time.

Why should the Chinese trust us to give them their money back, with interest?

People trusted Madoff because he was respected in a government regulated industry, but the government failed to do their job and his victims trusted the government. Who tried to blow the whistle on Madoff? A competitor. THAT is how trust is established, competition, independent and personal audits, and well publicized lawsuits.

Forests false notion of gold
You are wrong when you said that gold 'could not carry the burden of financial capitalism. But wait a minute, you could be called right if the burden is the governments desire to manipulate economies, pay for wars, buy votes, pay off cronies, etc. It is precisely because they cannot manipulate gold that politicians hate it.

The old lame notion that there is not enough gold is also nonsense. It has been discredited by many people for about the last say....100 years or more.

But thanks for taking over from Roy as an advocate for big government, fiat currency, authoritarian economics.

BTW, you never answered the question about what you call your own brand of economic thought.

gold is NOT an idle sorce of wealth
Here's only ONE example of when and where it wasn't. In the UK during the 19th century when they were on a gold standard, there was tremendous growth in the economy, productivity gains, investments in and out of the country.

Also, your notion of one banker grabbing up everything sounds like the old Marxist line of monopoly, whereby there will end up being only one banker, then only one capitalist; a notion disproven and discredited time and again.

money/wealth
Right, money is just one kind of wealth. Some people consider themselves to be wealthy because they have so many loved ones around them. Some other think they are wealthy because they get free nooky because of their fame(apparently there are even chess groupies).

Now you are getting silly.
How is money wealth?

why silly?
Money is considered wealth by many people because it allows them to buy things they otherwise couldn't have.

Wealth is free nookie?
"It was Adam Smith, in The Wealth of Nations, who exploded this silly notion. A people are prosperous to the extent they possess goods and services, not money, Smith declared. All the money in the world—paper or metallic—will still leave one starving if goods and services are not available."

"...as Adam Smith understood, money itself is not wealth; instead, it is a good that we use in order to obtain wealth."

http://fee.org/articles/the-fallacy-of-money-is-wealth/

Can't fool nature.
I submit money is a representation of energy from an economic perspective. When such energy is applied to reduce entropy (reduce the disorder) wealth is created.

A reason gold is useful to represent money is it does not corrode and it is relatively easy to process. Au stays Au unless you place it by a neutron source. Silver and copper both corrode.

The above is not intended as a reply to the Colonel.

Why must gold by transported?
Firstly, why do nation states maintain a gold reserve?

Isn't such a reserve considered real assets when it comes to exchanging currencies?

Certainly any asset needs to be valued in some sort of interchangeable unit. A bank could have valuable property as an asset to issue free market money against, but is its value in square feet, acres? Same problem with oil or crops or....
So, what is wrong with using the mass of gold for such comparisons? It has been done successfully around the world for centuries.
The only reason I can see to create a 'dollar' or a 'pound' or a 'franc' is for governments to control money instead of markets.

wealth as free nookie
Yes, I once knew a guy who was some sort of chess champion. He didn't really need the money he made from it, but told me that there is a class of 'chess groupies' so he could get laid easily even though he was old and ugly. Sure he was wealthy enough in monetary terms that he could pay for hookers, but he reports that it's abetter feeling getting if for free from such groupies.

Apparently other odd sectors also have such perks.

I know it's hard to believe, but I guess some guys really consider it a form of wealth being able to get laid so easily.

So what? The markets have spoken about their worth against gold
And they judge the fiats to be increasingly worthless.

"You hold onto those dollars as a store of wealth and buying power. You exchange your currency for other assets and resources, goods and services."

Yes, just as the vast majority of people (including Americans) did under the gold standard.

"Gold, for its part, is an idle store of wealth that does not produce income while it is sitting in your vault.."

So? The same thing can be said about dollars you stuff in your mattress. But wait! If you change those dollars into gold and keep them in your 'vault', their dollar-value seems to be increasing. Wow!

" If our inflation is modest...and it is...then the dollar is essentially flat. All other currencies and such precious metals as gold move up an down in relation to that nominal metric."

No. It is the gold that is the metric that the fiats are judged against, not the other way around. You seem to have a real hard time grasping this simple reality.

"Your confusion here is very natural because your understanding is completely intuitive."

No, my confusion is non-existent because I have studied the history of money and of gold as a form of it as well as when used as a 'peg' to regulate fiat currencies against it. I also see what the markets have to say on the matter, like so:
http://www.marketwatch.com/story/new-gold-bugs-taking-gold-mainstream-2009-11-23

Whereas you are just wedded to totally inaccurate dogma from the Wharton School.

Wrong on most counts
"After Bretton Woods in 1944 the global economy was tied to a fictional Gold Standard through the US dollar"

There was nothing fictional about it. They had to redeem dollars on demand for gold at $35/oz. If too many dollars were in circulation, then the demand for gold would increase relative to the dollars -- which is what is happening now -- and happened in the late 60s and then got really bad in the early 70s. Nixon then decided to bail out of the gold standard for THAT reason.

"Gold continues in its role as a store of wealth but it is not income-producing per se"

That can be said of all money that isn't circulated but simply hoarded. So what? People can't eat gold any more than they can eat dollars. They have to buy food.

"If you want to replace the dollar then you must come up with a currency that would be superior"

Where did I say 'replace the dollar'? I never said that. The dollar price just needs to go back to being pegged to gold. That's all.

"We moved away from gold because it could not carry the burden of financial capitalism"

No, we moved away from it because politicians went all Weimar Republic on us and instead of going back to living within their means, they just abandoned it.

The historical track record of the devaluation of the dollar since 1913 (when the Fed took over) and especially since 1973 speaks for itself.

Who is talking about no such thing as a fiat currency?
"These guys are talking about no such "fiat currency" at all as legal tender"

When did I say that, Forest? Ummm...NEVER.

Your misconceptions of how money operated under the previous modern gold standards are all that gave you that idea, not anything I said.

"The financial market could correct itself in this Darwinian manner but the bankers would always be watching for their best opportunity to grab everything they could carry and skip town."

Like they did with the current mortgage 'originate and unload on investors' scam? Hmmm...no gold was involved there, was it?

"There's simply not enough gold and transporting it around is extraordinarily disruptive. Not going to happen."

Correct. Who said that would be the case?

I wasn't clear enough
You are both right.

The global physical gold supply increases something like 2% per annum on average, from mining.

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