53 Comments

1. Gordon:

“… create or save 3 million jobs”? Unless you call welfare a job the government cannot create a job unless they themselves hire someone. Even then if it’s just make-work it’s not really a job. A “job” contributes to the total wealth; a make-work job only adds to the cost side of the equation.

I fear the Dems will try to make up some of this in part by squeezing the military–wouldn’t be the first time.

Jan 7, 2009 - 5:50 pm 2. Peter Boston:

There is a bit of logic that even a Harvard economist could understand. When you formulate a policy to create economic activity and jobs it may be a good idea to encourage those things that have most created economic activity and jobs in the past.

It’s called small business and entrepreneurism. It’s worked for about 230 years. Politicians hate the idea because it does not create dependent groups who will vote for the continuous handout.

Jan 7, 2009 - 6:28 pm 3. Tony:

Trouble ahead, lady in red,
Take my advice youd be better off dead.
Switchmans sleeping, train hundred and two is
On the wrong track and headed for you.

Driving that train, high on cocaine,
Casey jones is ready, watch your speed.
Trouble ahead, trouble behind,
And you know that notion just crossed my mind.

Trouble with you is the trouble with me,
Got two good eyes but you still dont see.
Come round the bend, you know its the end,
The fireman screams and the engine just gleams…

- Grateful Dead

Jan 7, 2009 - 6:34 pm 4. Insufficiently Sensitive:

Not one pundit has even whispered the word ‘inflation’, which would be inevitable with the presses spewing bills as fast as the Democrats (and Old Uncle Tom Cobbleigh and all) think necessary.

My little savings account is quivering in fear.

Jan 7, 2009 - 7:05 pm 5. wretchard:

Inflation is the tool of choice for creating a totalitarianism, whether wittingly employed or unintentionally created by mismanagement. Inflation wipes out fixed incomes and savings. People on salaries with savings accounts will find themselves pauperized overnight. Literal survival becomes contingent on “getting close” to those in power, who will provide the chosen few with indexed incomes or simply goods in kind.

Despots like Mugabe exploit this desperation to create units which are loyal, not to the institutions, but to the leader maximus personally. Once inflation bites there will be no shortage of people willing, nay clamoring, to do the bidding of the high and mighty. So from one point of view printing money is a coup de etat by those who control the currency. It gives them the ability to destroy all legitimacy save that of minter of money.

Of course it can’t last. Sooner or later it must all come tumbling down. But that’s tomorrow. Today it’s all sweet.

Jan 7, 2009 - 7:13 pm 6. Leo Linbeck III:

The last time we had double-digit inflation was in the early 1980’s, about 25 years ago. If you figure that you’d have to be about 20 years old to appreciate its effects, that means that anyone under the age of 45 has no idea of what it’s like to live in a high-inflation economy.

Approximately 62% of the US population is under 45, or about half of the voting age population. This means that half the electorate has no inflation experience.

It just so happens that Obama won 68% of the 18-24 crowd, and 69% of the 25-30 crowd.

Ignorance is bliss. For a while, anyway.

L3

Jan 7, 2009 - 7:24 pm 7. Unsk:

Me thinks that the economy will not be growing enough, (most likely shrinking for a while ) nor will the money supply be growing sufficiently to generate inflation. The banks need to lend for that money supply to get going and they are not. Deflation is the thing to be feared; it is much worse than inflation, and likely upon us if the Obama stimulus plan fails to stimulate as advertised. That said me thinks by next year there could be both deflation and significantly higher interest rates because financing a couple trillion in new bonds again and for the foreseeable future could be too much for the markets to take by next year. A fine mess the Dems have put us in!

Jan 7, 2009 - 7:41 pm 8. rickl:

I’m not an economist, but I’m thinking that an effort to ward off deflation will most likely overreach and spark runaway inflation instead.

Jan 7, 2009 - 7:55 pm 9. Dave:

I’m not allowed to run the train,
The whistle I cannot blow.
It’s not for me to say
How far the train is allowed to go.
I may not let off steam
Or even clang the bell.
But if the damned thing jumps the track,
I’ll be sure to catch all the hell.

Jan 7, 2009 - 9:20 pm 10. Dave:

L3: Still looks like deflation to me.
Money seems to be disappearing faster than
it is being issued.

Same thing happened throughout the 1930s.
Best explanation I can guess at is that
all that newly minted money is not chasing goods and services but is going for “vigorish”.

Your take?

Jan 7, 2009 - 9:24 pm 11. fred:

Someone please explain to me why hardly anyone remembers the problems of the Seventies and their disastrous consequences? Or, what it cost to put that beast back in the cage (the 1980-82 recession). I am just stunned that all of these advisers to Obama – nearly all of whom were old enough to have experienced that period – do not “get it.”

Jan 7, 2009 - 9:34 pm 12. fred:

And I do think these people are going to overshoot the target, in attempting to stop deflation, and will end up with rampant inflation as a result.

The job engine of our economy is entrepreneurism, start up companies, and small companies going public or expanding. The evidence is there. And big corporations and government do not create many jobs. Therefore, those policies which enable small businesses to get started and to grow are the policies we ought to be pursuing.

Jan 7, 2009 - 9:36 pm 13. Lifeofthemind:

For 45 years American cash was allowed to flow to oil producers and then into the banking system for recycling, a term that may have caught on in finance before it did in popular environmentalism. An increasing percentage of these assets have been flowing through overseas banks and into sovereign wealth funds to purchase capital assets rather than goods and services. At least however these funds were being spent to purchase something, the needlessly inflated price paid to the sheiks and the wasteful diversion of our economy from production to consumption not withstanding. Now trillions are being distributed by fiat and promptly transfered to some offshore depository.

I am aware of no precedent in history for any such reckless self destruction of an economic power. The closest that I can come up with was the impoverishment of Spain caused by the transfer and infusion of billions of dollars worth of precious metals after the conquest of the New World. The advocates of mercantilism thought their KIng would be made wealthier if his gold was moved to Spain and then spent, but not invested, there. The result was inflation and the impoverishment of the nobility, the corruption of the bureaucracy, the stagnation of the intellectuals, the depravity of the merchants and the debasement of the peasantry. The rise of a smarter hungrier power called England was also spurred by cupidity of Spain.

Jan 7, 2009 - 9:49 pm 14. weSwinger:

L3 has it right as usual. The striking parallels between now and the thirties are real asset deflation (real estate and equities) and the liquidity trap (credit sloshing around the system but nobody willing to lend). Of course it stops there. The Weimar Republic and the Mugabe regime chill the blood. Inflation’s clients are the creditors.

LOTM – how about the collective suicide pact of Ivy League Nincompoops?

Jan 7, 2009 - 10:11 pm 15. Lifeofthemind:

@weSwinger,
How about it? My guess is it runs Off-Broadway at best and folds after 6 weeks.

Jan 7, 2009 - 10:22 pm 16. Derek:

What happens if no one will lend the US treasury the money?

And how far off is that from happening?

Derek

Jan 7, 2009 - 10:41 pm 17. Iconoclast:

Is it really “self destruction,” or is it engineered destruction?

Jan 7, 2009 - 10:45 pm 18. R. Ford Mashburn:

I am reminded of Chernobyl by the “financial tinkering” going on at the Fed.
They tried to restart the reactor pile after cooling it too rapidly, and they pulled all the safeties to bring it back up to operating temp ASAP.

The result was overheating and explosion.

I have to wonder, since the risk managers didn’t adequately hedge against the downturn, why should we be confident that they can stop inflationary economics once they have restarted the economic growth?

I am 44. I remember what it was like during the last “inflationary crisis”. I remember what it was like trying to find a job during that time too. No picnic.

Jan 8, 2009 - 12:19 am 19. weSwinger:

LOTM + Icon – It’s been running itself and the rest of the country along with it into the ground from off-Broadway in Boston and D.C. for about the last 50 years and this year premiered on Broadway and Wall Street to lousy reviews and empty houses.

Our only saving grace is that the U.S. Treasury market still seems to be the best game in town. Everybody else sucks too. What’s the US $/Iceland Krona spread? A dollar.

Jan 8, 2009 - 12:20 am 20. Josh:

If the treasury can’t borrow it, they can still print it, devaluing the currency, raising the prices of real assets. IOW, igniting inflation, or hyper-inflation.

Heck, I originally thought that was Paulson’s proposal for the $700b. Perhaps it should have been. I’m afraid it will have that effect, even if “borrowed”.

Jan 8, 2009 - 12:29 am 21. Contrarian:

UNSK- Deflation is the thing to be feared; it is much worse than inflation”

Real inflation, the expansion of the money supply through using the printing press, is by far a greater thing to be feared than deflation, which is a shrinkage of the money supply. Deflation results directly in lower prices for goods and services. I am quite pleased to be paying $1.65 for a gallon of gas, rather than $4.50 as I was last summer. I can buy a nice house today for 40 – 50% less that three years ago. The price of commodities, including our food, is lower than a year ago. It costs less today to heat a home with natural gas than a year ago. What’s not to like!

Inflation benefits debtors, who pay their debts with depreciated dollars. Deflation benefits savers who can buy more for their bucks.

Inflation tears an economy and society apart, e.g., Weimar Germany and that crazy country in Africa. Deflation helps the market return to soundness in times of economic downturn.

The efforts of Washington to pump trillions of dollars into our economy undermines the corrective market forces that need to play out. Hoover and Roosevelt both did this, although on a much smaller scale, during the Depression years. The result was to drag the economic decline out for an entire decade. If the pump priming works and the economy roars back as a result of all the bailouts, then the effects of monetary inflation will become manifest and the consequences will be very, very bad.

Jan 8, 2009 - 12:40 am 22. rickl:

Yeah, I’m not sure I understand why deflation is so bad. Of course, I’ve never lived in a deflationary economy.

I know that inflation destroys people’s life savings and impoverishes them. That is obviously bad. So if my saved dollars become more valuable, how is that bad?

Jan 8, 2009 - 12:56 am 23. Unsk:

To the contrary, Contrarian,

The problems this economy faces are far more difficult to deal with than a bout of inflation 70’s style. Yes, there is always a chance that the Fed will over shoot it’s target and we will experience an inflationary spiral for a short time.

The Federal Reserve in the 1970’s particularly under William Miller was very lax with its monetary policy. At one point prior to Volker’s appointment, inflation was 13%, while interest rates were only 9%, so people were borrowing like crazy. Inflation came down fairly quickly under Volker’s two periods of tight money poliices, 1979 to 80 and 1981 to 84. Volker hated Reagan ’s tax cuts and slammed on the brakes once they were passed. Gas prices had already had come down because of Reagan’s deregulation of oil, and Reagan’s advisor’s had wanted to slowly restrain the still high money supply of 1981. Volker pushed the economy into a deep recession and kept money tight at least two years after the money supply and inflation were in the low single digits.

But the troubles of the 70’s and early 80’s ain’t nothin like we face now.

Lenders and investors are seriously risk adverse to new investment right now. We have not faced this situation since the 30’s. Credit is unavailable to many businesses that need it. Without credit, businesses not only can’t grow, they often must cut back business due to a lack of cash flow. Many will fail without proper cash flow. We are seeing that right now. Lack of credit and lack of consumer purchasing can create a snowball effect of business failures leading to more business failures.

This snowball effect creates a lack of demand for products and property where the market can no longer support prices, and prices start to fall and sometimes can crash. This is Deflation. Deflation destroys equity. Most property and businesses are leveraged by loans to a fairly high amount, often 80 % or more. When deflation eats away all the equity to where the loan amounts exceeds the value of the asset, the investments in businesses and property become worthless and in many cases can become a liability to the owner.

This is very serious stuff. We are already seeing huge estimates of business and property failures. Some experts expect foreclosures to hit 16% of all home mortgages. Others expect two to three thousand malls to go under. We are seeing office rents in places like New York and San Francisco dipping below the point that support most office mortgages.

The inflation threat pales in comparison. In the 70’s, monetary policy was far less understood. This Fed is not going to support the wild printing of money. It can’t; the market will devalue our debt to the point where no one will lend to us. The problem is where is the capital going to come from? China’s huge savings rate supported a world wide lending boom in the free world, the last decade or so. That’s all gone now. The US has a negative saving rate. The entire world is in a fix. Everyone could use some more capital right now. There are no bright spots. As bad a shape as we are in, with the exception of Japan, few countries are in better shape than we are right now. The financial market’s collapse have wiped out investments from around the world.
The pool of existing capital is still huge, but it is still shrinking because of the still falling markets and yes, deflation. Once, the existing pool of capital is lent out, there may not be more out there at some point to keep borrowing trillions at a time. So then what?

Obama’s plans so far don’t appear help the sectors of the economy that need the help the most. Tax cuts for the poor and lower classes, bailouts for the unions, the states and the local governments and goodies for the environmental lobbies, etc, aren’t going to provide the cash flow and the credit for the businesses and investors hurting now to stay afloat. Those expecting a rebound this year are deluding themselves, unless the capital markets improve quickly.

The Fannie/Freddie/CRA scam wrecked havoc on our financial institutions and the financial safeguards developed over several generations. Those safeguards and systems may need to be overhauled for our economy to fully recover.

Jan 8, 2009 - 3:25 am 24. Leo Linbeck III:

Dave,

You’re probably right – there’s still somewhat more deflation risk than inflation risk right now. But this can change pretty quickly.

Deflation risk is what is keeping money on the sidelines right now. In simple terms, why invest in an asset today that will be worth substantially less in a few months? So everything stays in cash.

But once that perceived risk goes away, there is a lot of money that will enter the system, and fast. 10 basis points is an OK return if there’s deflation, but not if there’s inflation. So everyone will dump Treasuries and start buying assets again, and the spiral goes the other way (I have to buy now, at any price, which leads to inflation, which leads to more buying, etc.)

The question at that point will be: will the Fed allow interest rates to rise so quickly? If people start dumping Treasuries, yields will skyrocket. The economist’s reaction will be: good news, deflationary risk is gone, and the economy has restarted. The politician’s reaction will be: stop! We’re just coming out of a recession, and we can’t kill the recovery will these high interest rates. They will push the Fed to keep rates down, and if the Fed caves, we’ll see rapid inflation.

The design margin here is very low. Fasten your seatbelt.

Cheers.

L3

Jan 8, 2009 - 6:00 am 25. Leo Linbeck III:

Unsk and Contrarian,

Great posts. I’m probably with Unsk on the relative pain of inflation vs. deflation argument. But both of you are right.

Inflation is worse for consumers (consumption), for the very reasons Contrarian stated. It slowly erodes their lifestyle, and wage increases tend to lag price increases, so the consumer is always behind the curve. This is demoralizing and painful, over a long period of time. It is especially painful for people on a fixed income.

Deflation is worse for producers (investment), for the very reasons that Unsk stated. It causes a death spiral, and the bottom is very difficult to predict. The common phrase is “catching a falling knife.” The fear of buying too early keeps everyone from buying, and demand collapses.

But, because a collapse in demand causes a sharp drop in supply, unemployment skyrockets. This is much more painful for wage earners than inflation. Better to lose 1% of your income to inflation than 100% of your income to unemployment.

Contrarian’s point about inflation and political instability really only is valid in the case of hyperinflation, which is a pure monetary phenomenon, easily corrected, and very unlikely to happen in the US. In some ways, hyperinflation is caused by political instability, not the other way around. And we’re actually a pretty stable political environment (perhaps too stable).

The key is what the Fed does after the market perceives deflation risk has ended. If they allow interest rates to rise, all of the extra money will get sucked back out of the system, and we’ll only have modest inflation, maybe 5-6%. But if they keep rates low in response to political pressure, inflation will spike into double-digits, and we’ll be back in 1980: stagflation.

There’s not a lot of room for error here. The one bright spot is that Volcker appears to have Obama’s ear, and he remembers all of this, and knows what to do.

Cheers.

L3

Jan 8, 2009 - 6:15 am 26. eah:

My recollection is that prices declined over a good bit of the 19th century, – not a bad century for the advance of liberty and prosperity. Perhaps deflation doesn’t have to be a bird of ill-omen, if the economy is structured to deal with it. Basically I would think investment would need to be built out of savings and retained earnings rather than debt and leverage. But I don’t pretend to economic sophistication.

Ed

Jan 8, 2009 - 7:25 am 27. Herb:

I heard Dick Morris discussing his theory that we are in for a period of deflation (caused by a lack of confidence and no credit) followed by rampant inflation (to cure the debt used to cure the deflation) followed by a severe recession to cure the inflation. All this is supposed to take 5 or 6 years to work out.

All this theory was in support of the idea that O will envy W’s popularity numbers within a year.

Volker isnt President. Obama doesnt understand free market economics. He fully demonstrated that in the campaign. (They both did) Anyone thanks that O can lead us out of this is nuts. All we can do is pray that a just God will have mercy.

Go read The Forgotten Man (Amity Schlaes).

In the mean time (no pun) the best investment may well be canned goods and ammunition.

Jan 8, 2009 - 7:59 am 28. slade:

I was wondering what happened to Amity Schlaes. She seemed to disappear almost as fast as Carolyn Kennedy. Her analysis was critically well received – was it not? – and yet Obama states that “economists agree” on the need for fiscal stimulus, presumably as they agreed that markets could manage all risk without external controls to mitigate the effects of extreme risk (although I liked the Chernobyl analogy.) I guess I would remind Obama that economists in agreement is not a good reality check.

On the subject of inflation versus deflation, I just finished reading “Forty Years a Speculator” by Fred Caruch. He buries the momentum school of trading as worthless. Real returns – as opposed to manipulated return metrics – cannot be generated as long as the “Nifty Fifty” are managed to meet quarterly expectations rather than long term growth, which requires at least a year, generally five. So “growth equities” aren’t – until management changes to allow earnings to breach the short-term (momentum-driven) boundaries for the sake of achieving long-term growth objectives. Many of the drivers behind deflation/inflation/stagflation derive from quarterly management to meet earnings expectations.

Jan 8, 2009 - 8:48 am 29. Unsk:

There are multiple problems with Obama alluded to multi year trillion dollar deficits:

• There may become an unwillingness of the private sector to fund this huge public debt to the point that interest rates will rise to where the return is deemed sufficiently high.

• The public demand for capital may crowd out the private demand for capital leaving less capital from which the private sector can grow.

• Overtime, even if there is deflation at home, the value of the our currency and our buying power abroad may be significantly reduced and devalued. All those foreign goodies we now depend on at cheap prices may get really expensive.

• Our ratio of public debt to GDP, roughly 0.7 in September, could go much higher to 1.5 or 2 or even 3 when you count all of the Fed’s loan guarantees that could easily go bad. These debt ratios could create crushing debt service costs and huge budget deficits as far as the eye can see.

Some reputable economists think a one shot big bailout deficit might be the ticket if it works, because the cost of public debt right now is very low. But I’m thinking given what I’m still hearing from Obama, Reid and Pelosi about the flatulence tax, higher payroll taxes for those earning over 100G, the carbon tax, the health care proposal, yada, yada, yada, that the Dem moves will depress the economy perhaps more than they improve it. Multiple year trillion dollar plus deficits will just kill us.

Jan 8, 2009 - 8:55 am 30. Derek:

How can the government borrowing somewhere in the vicinity of a trillion a year ‘loosen up’ the credit market? Who will lend to a business, homeowner, or even a municipality when the US Government is asking for money, and giving good returns?

We are seeing the tail end of a Keynesian bubble and inevitable crash. The US gov’t has been borrowing for years now, the last few has been borrowing the interest on it’s debt. This and the extremely low interest rates have driven the economy to over leverage. The nasty thing about being over leveraged, as anyone knows whose been around a bit, is that there is nowhere to go when things get a bit tight.

Anything the Fed does takes 18 months or so to effect. Hysteresis. So the Fed has pumped in money, dropped interest rates, and in another year + we will see effects of that. But, we are in budget time, and our savior needs to ‘fix’ things, so they too will do a bunch of things to stimulate. It too will have an effect with hysteresis.

Cash will lose value and people will be driven to spend. Of course the US gov’t will continue to borrow money at the same rate. No productivity gains will be had, no investment in anything of value. One bubble after another will be chased. The same fools that made this mess will be still running things because they were not allowed to go bankrupt. Government will react by attempting more fine control of the economy, which will create stagnation with rising prices. Unemployment will be a chronic 8-10% and the pundit class will opine that in those awful days of Bush they must have faked the unemployment rate. It couldn’t have been < 6%.

Deja vu all over again.

Derek

Jan 8, 2009 - 9:26 am 31. Jay:

Folks do not put much faith in modern economic theory especially macro economics. One of my academic titles is Professor of Economics and my department is considered to be good one. Most economists with the exception of Jim Buchanan and Gordon Tullock and others have almost a contempt for politics. For example many famous macro economists reject the political forces behind the Rubin and Greenspan easy money policy.
Tom Sargent (now at NYU) wrote a neat paper some years ago on how the Weimar central bank ended the German hyperinflation. He did not address why the inflation began. Was it because the head of the central bank slipped and hurt his head in the fall??
I have worked with physicists all my adult life as well as with economists and statisticians. Physicists are arrogant but there are rules they obey. Law professors are arrogant but they make up their rules. Economists are arrogant but think they are scientists because most use math models. Theuy confuse mathematics with science.
For example the Black-Scholes model used to price options uses a Brownian motion model that is obviously wrong since asset rates of return are not gaussian but the model posits gaussian increments.
Many of us do not believe that the Fed will be able to sanitize the liquidity it has put in the system once inflation begins.
As far as deflation is concerned we have to let the deleveraging work its way through the global economy. If firms go bust well that is part of the risk of capitalism. The attempt to avoid it will put us the type of wacko statist French socialist economy.

Jan 8, 2009 - 9:38 am 32. slade:

How to finance the proposed debt load?

My prediction:

This is a developing cover for forcing private retirement money into “safe” government debt. One of the issues that is going to come up in the next two to three years is financing all the new spending/borrowing. Raising taxes is hard politically, and likely couldn’t be done at a high enough level to make more than a small dent in the coming debt flood. One way to get around this is to create a private account for every American that invests in government long term debt. You fund this through payroll deductions above and beyond what is already taken for SS/Medicare, and you restrict 401Ks and IRAs by limiting the amounts that can be put in, or by completely elim[in]ating the tax deductions for those savings vehicles. – Yancy Ward (comments)

Jan 8, 2009 - 10:26 am 33. Robohobo:

“Inflation wipes out fixed incomes and savings. People on salaries with savings accounts will find themselves pauperized overnight.”

Or as we had bought into the idea of balanced investments in markets via various savings schemes have all of the profit and a good part of the principal cut out of those investments when the market tanks. I remember those days of recession and those who did lose their jobs along with their “savings” had little faith in the system. Here we are again. I have just lost the job and seen my “savings” eaten by the system. I will never trust it again. Investments for the future will be:

Canned goods
Rural land
Ammo
Guns
Silver or gold

After a couple of decades of new cars, I will be back to my old practice of “drive it until it drops” = buy a small, old truck for cheap and put nothing into maintenance except fluids and used tires when needed. The hell with pollution standards.

And the new politics:

Throw The Bums Out in 2010
Vote against the incumbent. Lather, rinse, repeat for several cycles. It is time to take the country back from the dark and sinister forces that have usurped it.

All this high talk of economics is fine, if you are not hungry.

Jan 8, 2009 - 10:53 am 34. elby:

I agree with Jay. I have no faith that the economic ‘elites’ will be able to deftly manage the money supply so that inflation doesn’t occur.

We have had a massive real estate bubble. The drop in prices is necessary. The price of real estate was not realistic. I just saw one of those real estate shows on TLC, must have been a repeat from last year. It showed several families ‘moving up.’ One couple was buying a modest 3 bedroom house, not sure where. The price? $750,000. That is seven hundred and fifty thousand dollars. Three quarters of a million dollars. Who can afford such prices? Even with some accumulated equity from a previous property, it is still crazy. Out of control prices like this are eventually going to result in a major drop. I am sorry for the people who got caught up in this. But sooner or later the piper must be paid. If we try to inflate our way out of this with another bubble we are only postponing the problem and making it worse in the future when the next bubble pops.

I have a background in physics, mathematics and neuroscience. The economy is a complex system. It cannot even be adequately described, a requirement for scientific study. Beyond that, economists cannot predict what state the economy will be in 6 months hence. How many told us oil was going to $200? How many accurately predicted the actual price of $50? I read somewhere that prior to a previous recession, 95% of all surveyed economists failed to predict it. This is the second requirement of science. A scientist cannot make a hypothesis, have it fail and then apply the same theory again, after vigorous waving of the hands.

If economists cannot describe the economy, and cannot predict its state in the near future, then it follows that they cannot control it. No amount of ‘add a little money here, tax a little there’ is going to make a difference, except in unintended consequences. The economy, an entity not amenable to reductionist theories, just keeps rolling along, doing what it will do. Economists trying to control the economy, whether through fiscal or monetary policy, is like a man trying to stop a speeding freight train. Only thing is, some attempts to stop the roaring freight train might just derail it.

Jan 8, 2009 - 11:08 am 35. Out of Control Spending:

[...] Fernandez vividly describes the situation: highlights the problem of what to with an alky who owns a distillery and is lying under the spigot [...]

Jan 8, 2009 - 11:27 am 36. Jrod:

Slade,
Amity Shlaes has a column on bloomberg today that may interest you. The subject is Madoff and “affinity fraud.”

Jan 8, 2009 - 11:44 am 37. slade:

Thanks Jrod. The riveting thing about Madoff is the suggestion that he is connected with the oligarchs of the Russian mafia. Missing money – $17B to $36B – can drive the imagination to weird places. In my view, considerable care should be exercised in using behavioral theory to explain what can easily be attributed to general stupidity. His – largely Jewish – investors got a rude wake-up call. One they won’t soon forget. What astonishes me – the point of her column I guess – is that so many fell for an obvious scam – the promise of high returns with little transparency. Those are red signals to most of us. More than “affinity” I am seeing arrogance – my man X can do the impossible because he’s one of us. For shame.

Jan 8, 2009 - 12:25 pm 38. Zim:

It’s getting pretty scarey out there. My neighbor put his house up for sale 2 months ago. His house was built the same year as mine, with similar dimensions and acreage. He slashed the asking price to 65% of what I paid for my house just 2 years ago (which was a steal at the time). He’s heard nary a peep from any buyer.

Nothin’s movin.

Jan 8, 2009 - 12:41 pm 39. Jay:

Elby, There is a field in economics called Complex Systems. It started out with the chaos fad. Most papers in this field are bull since the economists do not understand even linear dynamical systems. They use vector autoregressive linear models without realizing that they are discrete-time linear dynamical systems with constant coefficients. The solution to such systems are a linear combination of damped sinusoids (assuming stability of the system). Thus the only medium range forecasts that can be made from such models is an extrapolation of the trend. But the time series econs use a random walk model as the trend model. Granger got the Nobel Prize for this trend model for a system. A random walk with a drift has a zero probability of being near the mean trend line. Such a mistake shows their ignorance of diffusions.
The Black-Scholes model (another NP) is a gaussian random walk. My colleagues and I have shown years ago that stock rates of return are episodically nonlinear. They are obviously not gaussian. Yet these models are used to price risky assets.
It is one thing to have bad science and another to have bad science turn into justifying investment instruments and also to climate nonsense.

Jan 8, 2009 - 1:04 pm 40. Fletcher Christian:

Maybe some expert can tell me where my argument goes wrong here? I am addressing specifically the problem of tens of millions of people sitting in grossly overvalued properties, currently dropping in money value, and with zero or negative equity in those properties; while having severe problems paying for their mortgages.

It occurs to me that, at least for those in work, inflation is not actually a problem at all – at least, as long as everything goes up in step (with the possible exception of house prices). After all, if your salary goes up 25% and so do the prices of everything you buy, has anything actually happened? Of course, if you don’t move house, the cost of mortgage payments in this case becomes an ever-shrinking proportion of your income. The same applies to business loans applied to the purchase of property.

Thus, for anyone severely in debt, inflation is a Good Thing. And there are a heck of a lot of people, and a lot of businesses too, in that position. Of course, the income of the banks in real terms would shrink rapidly in such a scenario. Wouldn’t that be a crying shame? (/sarc off)

Jan 8, 2009 - 1:23 pm 41. cjm:

inflation makes overpriced houses easier to pay-off. it also makes govt. debt easier to pay off, say chinese bond holders.

Jan 8, 2009 - 1:24 pm 42. lucy:

The poem Richard quoted is “Death and His Brother Sleep” by Edwin J Milliken.

Jan 8, 2009 - 1:27 pm 43. Derek:

Fletcher and cjm: So what would be a ‘reasonable’ amount of inflation to help people out of this situation?

25%? Over what time period, a year?

Think that one through again. Especially since the government and economists are hoping enough people pour money into the US to cover the government debt.

Derek

Jan 8, 2009 - 1:52 pm 44. elby:

Fletcher Christian, inflation is bad because it rewards the wrong behavior and punishes good behavior. Going out and getting heavily in debt is bad behavior, regardless of how one tries to justify it. Saving your money for a rainy day, so you don’t have to run to government for a handout is behavior that should be encouraged. Inflation wipes out savings.

The economic situation with regard to two people I know illustrates this. My sister in law, call her Lee for now, has a husband who is dying of a neurodegenerative disease. He hasn’t worked in 8 years and before that underperformed in his career. Lee ended up nearly in foreclosure about 4 years ago as a result of this. I should add that it took over a decade to have her husband adequately diagnosed, so they could not plan for the consequences of this disease. People just kept thinking he should get a job. Lee felt horrible about her difficulties paying her mortgage, and worked two jobs. 10 -12 hour days in Manhattan and nights and weekends waiting tables. She was very good at her job, but unable to keep up due to the high taxes and high cost of living in NY. Eventually, she decided to sell her NY house and make a very difficult, I would say traumatic, move to NC. She was able to pay off her NY house and purchase a house outright in NC. She got out of debt. However, she bought only a house she could afford, which was a very modest home. She could really use a larger one, but she wanted to keep out of debt. Despite difficulties that far outstrip any sob story I have heard about people in foreclosure, Lee got out of debt. If she can do it, anyone can. It may be difficult, it may take time, and it will certainly involve loss. But it can be done.

Her sister, call her M, has lived a life 180 degrees opposite. Her husband is healthy, and owns a construction business in Fl. When times were good he went further and further into debt. They live in a huge minimansion. They have a jacuzzi. He gets a new truck whenever he wants one. Their home is luxuriously furnished, their kids have anything they want and they eat out at expensive restaurants often. Lee tried to tell M that going into debt was not a good thing. M and her husband refused to listen. It is interesting to note, that during Lee’s extreme difficulty with her sick husband, still ongoing, M and her husband have never so much as visited her nor offered her one dime. Now M and her husband are on the verge of bankruptcy. Their home is worth less than they paid for it. Boo-hoo. They are on the verge of bankruptcy. They richly deserve it.

A society cannot support this sort of overconsumption for very long. If we inflate our way out of it, we encourage M’s behavior and punish Lee. The grasshopper, who refused to put aside for the coming winter, now returns to turn the ant out of his house.

If you reward a behavior, you will get more of it. But the behavior of going into debt to overconsume things that are not needed is unsustainable. It simply cannot keep going. So we should not reward it.

Jan 8, 2009 - 2:08 pm 45. cjm:

i am not advocating inflation, just mentioning why it may be seen as useful in some quarters.

Jan 8, 2009 - 3:05 pm 46. Jay:

Elby is correct. Inflation can easily get out of hand. Democracies are inherently unstable.
Fletcher, not all workers can get raises that keep up with inflation and retired people lose. Inflation is a type of theft.
As far as producers are concerned they have to watch how much they borrow. Same holds for house buyers.

Jan 8, 2009 - 3:27 pm 47. maineman:

Wouldn’t it affect the inflation scenario if roughly half the population is over 50, just saw their retirements shrink 40%, and can’t expect to sell that house, building, or business that they thought was also going to help finance retirement? Those people (i.e. me) are going to work a few more years (or more, or less), save like crazy, and NOT put money back into the economy by buying and borrowing.

And to make matters worse, we restricted our reproduction and aborted about 30 million children that we really could use at the moment. Talk about cutting our own throats. Anyway, the problem again is not enough people to borrow and produce and spend energetically.

I’m not economically savvy at all, but that sounds more like a prescription for deflation than inflation. No?

Jan 8, 2009 - 4:02 pm 48. Fletcher Christian:

Consumption and the buying of homes are different. Note that there are probably quite a lot of people who, in practical terms, can’t readily move – and the rest of us wouldn’t really want them to; for example various types of emergency personnel who really need to live reasonably close to their jobs, for the benefit of the rest of us as well as their own.

I agree entirely with those who say that borrowing against property in order to buy the latest consumer toys is both reprehensible and stupid. Unfortunately, this behaviour drives up house prices for the prudent, as well. So people who actually are behaving responsibly are punished for the sins of those who are not.

This includes both the people who are remortgaging to buy toys and the bonus-chasing crooks who facilitate such behaviour. It applies especially to the members of the financial community who cover up the shenanigans of their fellows by wrapping up junk debt in ever-more-complex wrappers to cover up their stupidity and greed. Those who are simply struggling to buy a decent house are caught in the crossfire.

I have heard a new Internet meme that might be amusing. Unfortunately, it works better on the British side of the pond. It’s a new collective noun for bankers. The new word is “wunch”. Think about it.

Jan 8, 2009 - 5:02 pm 49. Bob Murphy:

Amazing thread, guys.
I understood enough to make it fascinating.

Jan 8, 2009 - 8:22 pm 50. PSL:

Jay @39. I’m one of those arrogant physicists, and spent over a decade working on non-linear dynamical systems, chaos theory. In the early 1990s I worked with some traders on the Chicago Board Options Exchange. It became clear pretty quickly that chaos theory wasn’t going to work, but that’s the point of doing experiments, find out if your ideas are connected to the real world. Out of curiosity I took a course by the Merc on options. They kinda-sorta used Black-Scholes, but they sure didn’t believe in Prof. Gauss. In fact they explicitly included very fast price drops in their options valuations. That’s the difference between risking your mortagage money every day and being an academic economist. If the economists stood in the trading pits for a few years or ran a small business and had to feed a few mouths, they’d be a lot smarter and a lot more humble.

Jan 8, 2009 - 9:46 pm 51. Dave:

@Jay: I think that our worst enemy today is the persisten illusion that there is or can be such a thing as macro-economic stimulation.

L3 and I and some others discussed this a month or two ago. All stimulation is necessarily micro-economic in nature.

And the good news is so is all economic disaster. Were it not for theis built-in damage controll system, H Sapiens would have perished of malnutrition eons ago.

BTW: Where can I get a glossary of all those
terms you were using? I reckon that you were debunking econometric modeling. That true?

My saying is that all those found guilty of econometric modeling should be sentenced to 30 years in solitary listening to the Knesset debate Keynes.

Jan 9, 2009 - 2:48 am 52. Bob Murphy:

Throw them in with the climate modellers peddling global warming, Dave.

Jan 9, 2009 - 4:17 am 53. slade:

Call the IPCC Dave. They’ll send you a 8-1/2 x 11 glossy glossary.

(In the 2004-05 time frame, on a site long ago, debate emerged comparing the virtues of econometric modeling with climate modeling. I have long blamed Bill Gates. Just kidding. But not by much. It strikes me as no coincidence that the computer modeling roared just as computational power soared. We’re now re-equilibrating to properly factor in human, uhm, behavior patterns, which are far from godly or gaussian.)

Jan 9, 2009 - 6:28 am

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