The deficit hawks will kill us

On February 28, I wrote a piece I am particularly proud of called Oil prices on the rise--inflationary or deflationary?  In it, I argue that while oil prices WANT to be inflationary, inflation cannot break out unless incomes rise.  Therefore expensive oil will almost certainly lead to deflation.  For years I have pegged Whitney as an inflation hawk so I am delighted to see he essentially agrees with me these days.

Bye Bye Recovery

Deflation is Right Around the Corner

By MIKE WHITNEY   April 18, 2011

In June, the Fed's bond-buying binge (QE2) will end and the economy will have to muddle through on its own. And, that won't be easy, because QE2 provided a $600 billion drip-feed to ailing markets which helped to lift the S&P 500 12 per cent from the time the program kicked off in November 2010. Absent the additional monetary easing, the big banks and brokerages will face a chilly investment climate where belt-tightening and hair shirts are all the rage. There's a good chance that stocks will fall sharply and that the tremors on Wall Street will ripple through the broader economy, further crimping the credit expansion and leading to a slowdown in personal consumption. As activity drops off, commodity prices will plunge and the telltale signs of deflation will reappear. So, the end of QE2 could be a tipping point, where the recovery strengthens and gains momentum or where the inertia of the underlying economy becomes more apparent and we backslide into negative growth.

Inflation is not the issue. In fact, Fed chairman Ben Bernanke has been doing everything in his power to create inflation, but with little success. Core inflation is still stuck at 1 per cent due to high unemployment and stagnant wages. If wages stay flat, then food and gas prices will eventually fall as demand erodes. It's simple, really; when the paycheck runs out, the spending stops. End of story. Speculators don't see it that way. They think the party can go forever, but they're mistaken. The commodities’ day of reckoning is fast approaching and it's likely to be a bloodbath. Here's a clip from a post by Tim Duy which explains why soaring gas and food prices are not really signs of inflation: 

"Inflation is not a general increase in prices. That is a one-time price increase, or a shift in relative prices. Inflation is a continuous increase in the price level, which, to be perpetuated, needs to be matched by increasing wages.... Without an increase in wages, the current gains in headline inflation will prove to be transitory." ("Misguided Meltzer", Tim Duy, Fed Watch)

Bingo. And wages are not increasing, so you can bet the higher gas and food prices are just a temporary blip on the radar. The United States is not headed for hyperinflation; that's nonsense. The country is in a Depression. If the Fed hadn't pegged rates below the current rate of inflation, then the economy would still be contracting today. But zero rates and lavish monetary accommodation have kept the ship aright. Still, that doesn't change the fact that we're still mired in a very deep slump. more 

Of course, the world's central bankers who are trained to find "inflationary pressure" in parts per trillion are about to make a difficult situation MUCH worse.

A Democracy Deficit

Tyranny of the Central Bankers

By DEAN BAKER   April 20, 2011

The European Central Bank (ECB) announced earlier this month that it was raising its overnight lending rate by a quarter of a percentage point to 1.25 percent. This is very bad news for people across the eurozone countries and possibly the rest of the world as well.

This action shows two things. First, the ECB is prepared to slow the eurozone economy and throw people out of work. This is the point of raising interest rates. The ECB targets two percent inflation with the current inflation rate in the eurozone around 2.5 percent.. The inflation rate is above the ECB target due to a jump in the price of oil and other commodities. These price rises in turn are primarily attributable to instability in the Middle East and increased demand from China, India and other fast-growing developing countries.

Raising interest rates in the eurozone will do little to reduce the prices of commodities. However if higher interest rates throw enough people out of work in the eurozone, it can place sufficient downward pressure on wages to offset the impact of higher commodity prices. If commodity prices rise by much more than two percent, then the ECB can make wages rise by less than two percent, thereby returning to its magic number and declaring 'mission accomplished'.

This brings up the other fact demonstrated by the ECB's action. It has learned nothing from the events of the last three years. Those who hoped that the worst economic downturn in 70 years might change the Bank's behavior are sure to be disappointed. It continues to adhere to its goal of maintaining an inflation target oblivious to the costs in unemployment and lost output.

Unfortunately, the ECB is not alone in this respect. Most central banks are now controlled by inflation targetters who explicitly ignore the impact of the banks' actions on output, employment and financial stability.

A deficit of democracy

The worst part of this story is that these fundamental decisions about economic policy are made by a small, secretive clique operating largely outside of the public's purview. Central bank decisions on interest rates are likely to have far more impact on jobs and growth than any of the policies that are debated endlessly be elected parliaments. Yet, these decisions are made largely without democratic input.

In fairness, politicians bear much of the blame for this situation. They established institutional structures that largely place central banks beyond democratic control. There is probably no bank that is as insulated from the democratic process as the ECB, in large part because of its multinational structure, but all the central banks in wealthy countries now enjoy an extraordinary degree of independence from elected governments. In many countries they are even more independent than the judicial system.

Even worse, the politicians have actually mandated many central banks, like the ECB, to pursue an inflation target to the exclusion of other considerations. This gives the central bankers a license to throw millions of people out of work in order to chase their obsession with inflation. more

And of course, there has to be a serious discussion for why economic fears must lead to the destruction of social programs.

Deficit Hawks One Two Punch

December 16, 2010 By Michael Hudson

Why Government is More Afraid of Debt than Depression

Michael Hudson: Deficit Hawks Want a One Two Punch Against the Economy more

Then there is this little problem that because labor statistics have been so watered down in the past 35 years, it is incredibly difficult to mount a statistical case for a jobs program (for example.)

Obama's Focus Should be Jobs, Not Deficits

The Invisible Recession

By DEAN BAKER   April 18, 2011

Millions of Americans are still suffering from the Great Recession. People across the country are struggling to find jobs, and families nationwide have had banks foreclose on their homes. It is against this backdrop that President Obama gave his speech on the budget.

While he did make the point that the wealthy can afford to pay more taxes, the speech confirms the administration's agenda of deficit reductions. But with an 8.8 percent unemployment rate, a budget agenda that stresses jobs is what the nation needs.

To understand why the focus should be on jobs instead of deficit reduction, it is important to remember how we reached this point.

Two years ago the economy was in a free fall as a result of the collapse of the Wall Street-fueled housing bubble. In the four months between December 2008 and April 2009 alone, the economy lost more than 3 million jobs; it would go on to lose nearly 5 million more.

Almost $8 trillion in housing bubble wealth disappeared as house prices plummeted.

The private sector lost more than $1.2 trillion in annual demand, roughly half of this due to lost construction demand and the other half due to lost consumption demand.

President Obama rightly proposed a second stimulus package -- the first was passed in February 2008 and signed by President George W. Bush -- to try to make up for lost demand from the private sector.

Government stimulus was the right path because private sector spending would not increase on its own. There is no magical potion that can somehow generate $1.2 trillion in new demand from the private sector alone. Businesses invest and hire when they see demand for their products. They all had huge excess capacity in 2009; this meant that there would be little new investment.

Similarly, consumers were heavily indebted now that they had lost so much housing wealth. This meant that they would not consume.

If the government did not spend money, no one was going to. This would have meant high unemployment rates long into the future, just as happened during the Great Depression.

The stimulus package helped to reverse the economic decline, but it was not nearly large enough. The package came to roughly $300 billion a year in tax cuts and new spending, roughly one-quarter the size of the shortfall created by collapse of the housing bubble. And much of this stimulus faded out by the end of last year. more

And for the first time in my memory, folks are beginning to bring up the possibility of just hitting the reset button on all this global debt.  Baker must know the reaction to this piece but wrote it anyway.  And while a debt default would be a good thing for the vast majority of USA citizens, it really would be the end of the world as the idle rich know it.

U.S. Debt Default Would Not Be The End Of The World

Dean Baker:

The NYT had a piece on the implications of the United States hitting its debt ceiling and running the risk of defaulting on its debt. The article exclusively presented the views of people who portrayed hitting the debt ceiling and defaulting on the debt as being an end of world scenario.

It would have been useful to present the view of people who do not consider a default on the national debt to be the worst possible outcome. While there can be little doubt that a default on the U.S. debt would lead to a financial crisis and would likely permanently reduce the role of the U.S. financial industry in world markets, it is also likely the case that the United States would rebound and possible rebound quickly from a default.

The experience of Argentina may be instructive in this respect. Argentina defaulted on its debt at the end of 2001. Its economy fell sharply in the first quarter of 2002 but had stabilized by the summer and was growing strongly by the end of the year. By the end of 2003 it had recovered its lost output. Its economy continued to grow strongly until the world recession in 2009 brought it to a near standstill.

While there can be no guarantee that the U.S. economy would bounce back from the financial crisis following a default as quickly as did Argentina, it's unlikely that U.S. policymakers are too much less competent than those in Argentina.

Readers should be made aware of the fact that countries do sometimes default and they can subsequently recover and prosper. Many people may consider the short-term pain stemming from a debt default to be preferable to the long-term costs that might come from policies adopted to prevent default. more