Ex Fed Chairman Volcker Warns on Economy

disco

Thu May 15 10:39:45 -0700 2008

A comment on whether or not "core" inflation figures should include food and energy prices. It depends what you are using the rate for. If all you want to know is the impact and trend on people's budgets then yes, you want certainly want to include food and energy. But if you want to know the impact of the only item you can control (e.g. monetary policy) on the prices of goods and services then perhaps you do want leave out food and energy because their price is impacted by many variables, of which monetary policy is only one. If inflation measurements go up because of the price of oil goes up, it doesn't necessarily mean it's going up because Fed rates are too low. It maybe going up because of increased demand from elsewhere (e.g. China), or some upheaval in oil producer (Iran, Iraq, Venezuala, Nigeria). The impact of oil prices on inflation measurements is meaningless in these scenarios (for Fed policy), so they exclude it altogether to ensure the measurements are meaningful to their policy decisions.

If you want the inflation rate that includes food and energy you still have it: the CPI. It is measured and released by the government. The comments associated with that last Technocrat inflation article imply that the government is hiding something from us. No, the Fed is just using a different number for monetary policy decisions.

And on this article in general: How surprising that Technocrat posts a pessimistic economic article. There are opposing views to the depth of the economic downturn. I'm not saying that we're not in a slump right now. I'm saying that there is a balance issue when Technocrat links to economic articles.

Ex Fed Chairman Volcker Warns on Economy

Uncle Entity

Thu May 15 12:02:03 -0700 2008

Yeah, that wsj article is pretty optimistic... stagflation is much better than recession.

Which of course brings Volcker out of the woodwork. Eventually the Fed is going to have to do what he did and ratchet up interest rates, the super low rates are what got us in trouble in the first place. What we have now is a post-inflationary boom inflationary boom but it isn't working out quite how they intended. You really think the Fed meant for all that money to go into a commodity boom?

The next perfect storm is on the horizon, businesses that relied on low interest rates to fund projects that turned out to be malinvestments are still being liquidated due to the credit crunch while the money that usually went into making loans to businesses is bidding up the price of everyday goods, indirectly through the commodity markets. Businesses pay more for raw materials, can't get financing and are finding it very hard to pass on increased costs to their customers.

Two choices, either we continue to limp along this way like the '70s or they allow the liquidation process to occur and we can get back on track like after Volcker took the drastic actions he did. OK, there's a third choice—abolish the Fed and treat fractional reserve banking as the fraud it is but I really don't see that happening anytime soon.

Ex Fed Chairman Volcker Warns on Economy

disco

Thu May 15 14:11:31 -0700 2008

> The next perfect storm is on the horizon, businesses that relied on low interest rates to fund projects that turned out to be malinvestments are still being liquidated due to the credit crunch ...

The worst of the credit crunch is over. We're coming out of it now. Lending won't be as loose as it was pre-crunch. It will be more risk-averse, but it will flow to those who can pay it back.

> OK, there's a third choice—abolish the Fed and treat fractional reserve banking as the fraud it is

Who is the victim of this "fraud"? In the previous paragraph you suggest the ongoing credit crunch is going to cause "the next perfect storm", and then you finish your post by suggesting we move to an eternal credit crunch.

Ex Fed Chairman Volcker Warns on Economy

Uncle Entity

Thu May 15 17:08:48 -0700 2008

The worst of the credit crunch is over. We're coming out of it now. Lending won't be as loose as it was pre-crunch. It will be more risk-averse, but it will flow to those who can pay it back.

Until they raise interest rates again and we get back to where we started.

The problems with these inflationary booms is eventually the bad investments need to be liquidated because they aren't profitable at higher interest rates. Look at the subprime crisis, people got in trouble when the Fed started raising rates and their payments were outside their income range — the exact same principle applies to businesses who start projects that are profitable at the current 2% Fed rate (with middleman markup) but as soon as it goes to say 3.5% they start to lose money.

The whole point of the Fed's actions as of late is to keep the malinvestments from having to be liquidated so the economy doesn't go into a recession. This is only sustainable for so long and nobody really knows where the breaking point is, Bear Stearns could have been it if the Fed didn't step in with a quick 29 billion dollar bailout. Or maybe the ramifications of the Fed having over 50% of their assets in crap the banks couldn't use as collateral because they are of questionable value will take the system down. Nobody knows.

Who is the victim of this "fraud"? In the previous paragraph you suggest the ongoing credit crunch is going to cause "the next perfect storm", and then you finish your post by suggesting we move to an eternal credit crunch.

Growth based on real wealth instead of fraudulent claims to real wealth would be so bad?

But the victims of this fraud are anyone who has their assets devalued through the issuing of these wealth claims, namely anyone who holds money. Anytime the banks or government produce money through fractional reserve banking or monetizing debt they are laying claim to real goods through counterfeit currency. They didn't produce wealth but the illusion of wealth through this process.

Same as if I were to go down to Kinkos, print up some hundred dollar bills and go on a spending spree. Well, with the subtle difference they would hunt me down and lock me up to protect their monopoly on the issuance of currency. Same concept though.

Ex Fed Chairman Volcker Warns on Economy

disco

Fri May 16 06:24:42 -0700 2008

> Look at the subprime crisis, people got in trouble when the Fed started raising rates and their payments were outside their income range — the exact same principle applies to businesses who start projects that are profitable at the current 2% Fed rate (with middleman markup) but as soon as it goes to say 3.5% they start to lose money.

The loaners in these situations lose too. These people (and businesses) should never have been given the loans in the first place. Lesson learned by the financial world.

> But the victims of this fraud are anyone who has their assets devalued through the issuing of these wealth claims, namely anyone who holds money.

People who "hold money" can and should take advantage of wealth creation, by diversing said money. If you have money you're not losing out on this system. Long term the stock market index funds earns 10% per year, which is significantly higher than inflation.

> Bear Stearns could have been it if the Fed didn't step in with a quick 29 billion dollar bailout ... Nobody knows.

Right. The question is what could have happened to the financial markets if the failing of Bear wasn't it? Could there have been a domino effect that took down everybody? I'm not knowledgeable enough to say, and perhaps nobody else is either, but the Fed obviously saw a non-neglible risk there, and took action, even if it meant more exposure for themselves. Right decision? I think most experts are saying "yes".

> Same as if I were to go down to Kinkos, print up some hundred dollar bills and go on a spending spree. Well, with the subtle difference they would hunt me down and lock me up to protect their monopoly on the issuance of currency. Same concept though.

No, it's not. Banks are not printing money. They are taking a risk in giving you the loan, and the loan is usually backed by assets of the loanee. Besides any current tangible assets backing the loan, it is backed by a speculative asset: future earnings of the loanee. Loans take advantage of an economic truth: economies grow & wealth (real tangible wealth, not printed money) is created. The money they are loaning or the treasury bill they are selling is the wealth of tomorrow. It is very real.

If they were just printing money how would Bear Stearns, UBS, Citigroup, ... etc be in the situation they're in? They lost in this case because that "loanees wealth of the future" was non-existent in the failed loans. i.e. they lost because they tried to print money based on nothing. They certainly are paying for it. Not something they'd be doing with $100 bill and a Xerox machine. Zimbabwe prints money. How's it doing?

Your analogy is wrong, and a bunch of Technocrats fall for it.

Ex Fed Chairman Volcker Warns on Economy

Uncle Entity

Fri May 16 14:35:42 -0700 2008

No, it's not. Banks are not printing money. They are taking a risk in giving you the loan, and the loan is usually backed by assets of the loanee.

Ok, Let's say I deposit $10 in my checking account. The banks takes $9 of this and loans it out while keeping $1 as their reserve requirement.

Now you have $10 + $9 in demand deposits and $1 + $9 in assets.

While they didn't literally 'print' $9 in this scenario it was produced out of thin air...

Besides any current tangible assets backing the loan, it is backed by a speculative asset: future earnings of the loanee.

Now the person who took out the loan spends it.

Bank balance is now $10 in demand deposits and $1 + $9 in assets.

The ability of the bank to pay back my money is now tied to the future earnings of the loanee in total opposition to bailment law. The ability of the bank to keep out of bankruptcy is dependent on my keeping it in their bank instead of 'demanding' it.

Don't get me wrong, if it were a case of a time deposit or a savings account where it were disclosed that the money isn't available 'on demand' there is no problem with this system. The problem comes with having multiple claims on the deposited money, vastly simplified in this example, where if too many people decide to withdraw their money at the same time the banks don't have sufficient assets to back all the claims and close the doors...or currently the US taxpayer gets to fund this risk through FDIC.

If they were just printing money how would Bear Stearns, UBS, Citigroup, ... etc be in the situation they're in?

If you accept that interest is an indicator of the demand of a currency then producing a whole lot of currency to keep interest rates down will decrease demand because anyone who wants money can get it virtually at will. So the banks that get this newly created money have to get creative in loaning it out in a saturated market, giving out riskier and riskier loans. Then you end up with things like No Income, No Assets (NINA) loans wrapped up in baskets and sold to investors as AAA risk securities.

It is seriously doubtful that banks would hand out half a million dollar loans to someone who just writes down what they earn and assets they own without a single check (apparently they made a few of these loans to deceased people too) if there wasn't this glut of money entering the system. Or the dot com boom where people were able to get financed with an idea, no business plan or anything really.

Ex Fed Chairman Volcker Warns on Economy

disco

Fri May 16 15:19:05 -0700 2008

> Ok, Let's say I deposit $10 in my checking account. The banks takes $9 of this and loans it out while keeping $1 as their reserve requirement. Now you have $10 + $9 in demand deposits and $1 + $9 in assets. While they didn't literally 'print' $9 in this scenario it was produced out of thin air...

The bank still owns whatever that $9 was used to purchase plus, over time, interest. Agreed, the $9 is no longer liquid, and in this scenario (one depositer and one borrower) a depositer requested withdrawal of $10 would cause some turmoil. Yes, this is a risk with fractional reserve banking, but in my opinion (and the whole financial establishment's opinion) a risk where the positives (credit availability & the resulting ability to grow the economy, wealth, and wellbeing of the people) vastly outweigh something that rarely occurs (runs on banks). It's not in anybody's interest, neither the banks, the depositors, or the loanees, that the banks put themselves at risks of a run, so it rarely occurs. The amount of losers in fractional reserve banking is miniscule compared to the winners. If we didn't have fractional reserve banking you could roll back our development by a few decades.

> So the banks that get this newly created money have to get creative in loaning it out in a saturated market, giving out riskier and riskier loans. Then you end up with things like No Income, No Assets (NINA) loans wrapped up in baskets and sold to investors as AAA risk securities.

Partly, but you oversimplify what happened. For a fascinating layman's view on the chain of events I recommend This American Life's podcast interviewing some of the players in the chain of events (they only make it free for a limited time, so hurry while stocks last).

The mistake you make is you imply that this risky behavior situation is still business as usual. The banks were not winners in this mess. They've learned a lesson. They're going to much more stringent moving forward, at least for a couple of decade or so, until the next generation of bankers comes in with no recollection of the 2000s housing bubble :-)

 

Ex Fed Chairman Volcker Warns on Economy

Uncle Entity

Fri May 16 15:48:11 -0700 2008

It's not in anybody's interest, neither the banks, the depositors, or the loanees, that the banks put themselves at risks of a run, so it rarely occurs. The amount of losers in fractional reserve banking is miniscule compared to the winners. If we didn't have fractional reserve banking you could roll back our development by a few decades.

The banks put themselves at risk for a run as soon as demand deposits are higher than liquid assets, 100% reserve banking.

This is why we have a banking cartel, fiat currency and taxpayer funded insurance on deposits because the system is unstable. Oh, and don't forget the government confiscating the private property of its citizens when it made gold illegal because they knew that given the preference people would have returned to specie as they have after every other failed fiat currency in the history of humanity.

There is no way to tell what would have happened in the absence of FRB but historically speaking periods where the gold standard was re-established there was always high growth. The kind of growth we see today isn't sustainable as can seen from the regular business cycles which, incidentally, the New Economy was supposed to cure.

Yeah, I heard that show...I especially liked the 'Global Pool of Money' euphemism. They don't teach business cycle theory anymore since it was 'cured' so they left out the Fed's role in the whole fiasco but other than that it was a good show.

Yup, they learned a lesson, the business cycle is cured yet again...