Causes Of A Great Inflation: Tunneling For Resurrection

Here is Ben Bernanke’s problem.

1. The financial sector is busy setting up arrangements in which employees are guaranteed high levels of compensation if they stay on through the difficult days ahead.  These retention-type payments allow firms to survive in their existing form, pursue business-as-usual, and gamble for resurrection, i.e., make further risky investments.

2. But these same payment schemes, e.g., Goldman Sachs’ loans-for-employees deal, are a form of poison pill with regard to further bailouts – the Administration may want to help these firms down the road, but this kind of tunneling means Congress will put its foot down.  Do you think that President Obama’s $750bn for bailouts (scored as $250bn) will survive the budget process?  No New Bailout Money is a slogan reaching from here to the midterm congressional elections. 

3. And the financial system is in big trouble.  Unless the economy turns around, somewhat miraculously, we are in for a big slump.  Or even for a Great Depression – watch closely the words and body language in Bernanke’s interview on 60 Minutes

The big banks are essentially making themselves Too Politically Toxic To Rescue, and this has potentially bad macroeconomic consequences.  So what will Bernanke do?

As he sees the world, there is only one course of action remaining: print money and hope for a moderate degree of inflation.  The money part was, of course, the announcement yesterday from the Fed.

The inflation part is a leap of faith.  If inflation is driven by the so-called “output gap,” i.e., how far the US economy is below potential output, then prices will not increase much, the yield curve steepens moderately, and banks make out like bandits (it’s just an expression). 

But if the whole world is moving more into an emerging market-type situation then (a) inflation expectations become deanchored (central bank jargon for “really scary”), (b) potential output falls as we massively deleverage, and (b) people move increasingly into alternative assets – storable commodities spring to mind – and we get some serious inflation. 

If oil prices jump, then we have an even bigger inflation problem.  Oil is not storable, supposedly.  But if you can explain to me exactly why oil prices rose as they did during the first part of 2008, despite the slowing global economy, I might be greatly reassured that we are not heading immediately into a runaway inflation spiral.

 

By Simon Johnson

100 responses to “Causes Of A Great Inflation: Tunneling For Resurrection

  1. I’ve been putting some thought into this and the real problem with debt deflation cycles is NOT the deflation of general prices, but the deflation of wages. I would hate to see a scenario where even a modest dose of general price inflation is created but incomes remain stagnant. If households are struggling to pay their debts now, a modest increase in other required expenses like food and utilities only adds further pressure to household balance sheets and increasing risks of default – think $4 gasoline in summer 2008. The only way out of this is wage inflation and or writing off the bad debts, because that’s the real problem. People lent money to other people who couldn’t handle the debts and the debts did little or nothing to increase income streams to pay for them. In any other day to day operation you’d go to bankrutcy court and the debts would be cleared if the couldn’t be paid. Until we reach that understanding we’re only doing things to risk making it worse.

  2. Clifford Nelson

    The expansions of the fed’s balance sheet will hold interest rates down for how long? Lets take bets?

    What do you say Simon?

    Is it not true that there is the “other side’ to each of these actions?

    Have we not put ourselves at the mercy of those who own gov’t’s debt?

    Also, interest rates are low by historical standards and it hardly seems to be stimulating much.

    What does the fed think is going to happen? Interest rates move down 100 basis point and that will be enough?

    What if they are wrong?

    What if they are wrong and the moves push people that hold our debt away and interest rates in the longer short term move up?

    Mercy!

  3. I’m assuming when you discuss inflationary expectations becoming deanchored, you’re referring to a global phenomena that effects all currencies. It essentially would be the demonetization of the global economy, or the fall of civilization.

    Isn’t this “Mad Max” scenario a little far-fetched?

  4. Very interesting post, and that is an excellent point about oil prices in 2008, which should be a big topic of discussion by the Obama administration, if only to try to understand why it happened. Does ANYONE have any idea about what was responsible for the rise in oil prices in 2008, apart from the obvious candidates such as speculators, hedge funds, etc.
    What is it about futures markets that allowed the price rise to happen?

  5. That too is roughly my take on yesterday’s developments in Congress and at the conclusion of the Fed’s meeting. The backlash in Congress about perception of AIG looting means the Fed feels like its all alone. Inflation may stimulate risk taking, help debtors, and demand for real assets such as houses. Yet, that won’t cure the oversupply in the housing market. Inflation is the risk the Fed is willing to take even if the CPI rose by 0.4 in February. Thus, at a nearly 5 percent annualized inflation rate based on the February number. The current data does not seem to support the deflation hypothesis. The Fed can solve the problem of money creation, but it cannot make efficient lending decisions for zombie banks.

    I did hear there were some moves by the administration yesterday to get authorization to have a new bankruptcy procedure for bank holding companies and large, complex, financial institutions. The only politically palatable alternative to regulatory forbearance is some form of receivership, but the FDIC is hesitant to act without clear authority. Receivership for insolvent institutions is what I argued for in http://ssrn.com/abstract=1343625.

    Further, congressional appropriations to inject capital are increasingly unlikely. The Treasury should sell its preferred stock holdings to third party investors to raise money for common stock injections. (Common stock is much more effective than preferred stock in improving lending incentives for undercapitalized but still solvent institutions see http://ssrn.com/abstract=1321666 and http://ssrn.com/abstract=1336288.) Yet, I believe they are worried about realizing the losses on their preferred stock holdings, and the Congressional reaction from that move. Treasury can always blame the previous administration on the losses to the preferred stock investments. (It was Hank Paulson’s fault that the dividend on the preferred stock was set at 5 percent of par.)

  6. Gold also will probably play a role in helping evaluate the deanchoring of inflation expectations. One day definitely does NOT make a trend, but the $60 pop in the barbarous relic is a noteworth move.

    Regarding the oil markets in 1H 2008, the commodity index funds were allowed a special exemption from position limits – and while correlation does not prove causation, the peak in oil did correspond almost directly with hearings in Congress about reining in the speculators.

    Maybe I’m too old school, but I thought that nearly all of the pre-deregulation protections (Glass-Steagall, 50% margin requirements, no shorting on upticks, strict position limits, etc) worked very well and contributed to a liquid and sane marketplace.

  7. Simon van Norden

    Simon;

    I don’t want to add to the gloom, but output estimates are very poor predictors of inflation. Part of the problem is that the degree of inflation predictability has lessened greatly since the mid-80s. The other part is that output gap estimates and forecasts are greatly revised after the fact; revised gap estimates show a much better fit to inflation.

    How are the revised estimated constructed? One popular way is to maximize their ability to fit inflation! (The technically inclined can look up Orphanides and van Norden 2005 JMCB for a technical analysis of the ability of output gaps to forecast inflation.)

  8. One possilbe reason…

    To quote the immortal Will Rodgers on real estate “They ain’t makin it no more’.

    The blogosphere is alive with the sound of ‘peak oil’ drums being beaten at an ever louder volume.

  9. That too is roughly my take on yesterday’s developments in Congress and at the conclusion of the Fed’s meeting. The backlash in Congress about perception of AIG looting means the Fed feels like its all alone. Inflation may stimulate risk taking, help debtors, and demand for real assets such as houses. Yet, that won’t cure the oversupply in the housing market. Inflation is the risk the Fed is willing to take even if the CPI rose by 0.4 in February. Thus, at a nearly 5 percent annualized inflation rate based on the February number, the current data does not seem to support the deflation hypothesis. The Fed can solve the problem of money creation, but it cannot make efficient lending decisions for zombie banks.

    I did hear there were some moves by the administration yesterday to get authorization to have a new bankruptcy procedure for bank holding companies and large, complex, financial institutions. The only politically palatable alternative to regulatory forbearance is some form of receivership, but the FDIC is hesitant to act without clear authority. Receivership for insolvent institutions is what I argued for in http://ssrn.com/abstract=1343625.

    Further congressional appropriations to inject capital are increasingly unlikely. The Treasury should sell its preferred stock holdings to third party investors to raise money for common stock injections. (Common stock is much more effective than preferred stock in improving lending incentives for undercapitalized but still solvent institutions. See http://ssrn.com/abstract=1321666 and http://ssrn.com/abstract=1336288.) Yet, I believe they are worried about realizing the losses on their preferred stock holdings and the Congressional reaction from that move. Treasury can always blame the previous administration on the losses to the preferred stock investments. (It was Hank Paulson’s fault that the dividend on the preferred stock was set at 5 percent of par.)

  10. Simon van Norden

    One more question;

    How exactly does this inflation get started?

    1) We can’t point to gaps, bottlenecks, capacity constraints, external supply shocks.
    2) Why exactly is a vast increase in the money supply inflationary if we’ve seeing a huge drop in velocity? Does deleveraging not imply a big drop in velocity? or is the increase in the supply too big relative to that drop? or is it the risk that deleveraging could reverse faster than the money supply could be contracted?
    3) Most (all?) of those emerging-market type situations have rapid large depreciations/devaluations as big contributors to the inflation shock. Is that essential in your mind to the US inflation-risk?
    4) If we don’t have at least one of the above 3 above elements, would you agree that inflation expectations should stay anchored? (or at least that important positive inflation would not be expected?)

  11. This is where the lack of a theory of asset valuation in the macroeconomic model is a critical problem.

    With the economy not facing immediate real capacity constraints (at least in commodities, manufacturing, energy, and service sectors other than health care), risk to inflating CPI is less of an issue.

    I suspect the real hope is that _fear_ of inflation causes investors to shift assets out of cash and into inflation resistant investments – especially stocks, real estate, etc. This reflates those assets (essentially, homes and stock investments). This then induces an increase in perceived wealth (and a decrease in anticipated bank losses), and the weatlh effect translates into an increase in aggregate demand.

    Likewise, the Fed aims to destroy _expectations_ of falling prices, which has been keeping potential home buyers on the sidelines (not because they can’t afford mortgages, but because they are afraid prices could fall more).

    Simultaneously with reflating asset values, the Fed efforts to keep _certain_ interest rates low (notably, mortgage rates and T-bill rates) by buying securities amounts to an effective subsidy to indebted homeowners. In other words, it’s a way to bring incomes into line with home values without dropping _nominal_ home values (and inducing loan losses/worsening of the banking situation).

    I’ve mentioned earlier that oil is the greatest risk in this strategy, due to the inelastic demand curve (though it appears more elastic than we thought). The mid-January speculative behavior (e.g. investment banks filling tankers and parking them offshore) may help buffer against this in the short term. In the long term, demand needs to be managed aggressively (e.g. better energy technology).

    Open has signalled it will be happy with prices in the $70 to $90 range for the next few years. We know the downside; the upside is that these sorts of prices should keep up pressure on the US to shift to a real sustainable energy model. (Congress has a notoriously short attention span.)

    Finally, note that the Fed’s authorization to purchase only $300 billion in T-bills is not a blank check to Congress – that can’t come close to soaking up the 1.7 trillion deficit. The Fed is clearly still inflation conscious. However, it does send a strong message that the Fed is serious about the money supply.

    Assuming this succeeds – let’s hope and pray it does – the next real challenge becomes following through with the _structural_ changes to the US economy that are being planned by the Obama Administration. Without deep and real changes to energy, health, education, infrastructure… long term federal deficits will still sink the country.

  12. “Open has signalled” should read “OPEC has signalled”

  13. The hope is that inflation _will_ stimulate home-buying. The thought is that the trend of falling prices has resulted in pent up demand. Potential buyers are delaying purchases due to the _perception_ of falling prices. By creating the perception of rising prices, the pent up demand becomes actual demand, and home prices stabilize.

    Anyway, that is the hope.

    As to inflation, I think economists have confused asset price inflation and inflation of consumption goods (CPI). For example, the failure to include home mortgage payments in CPI is at least one critical flaw.

    Finally, here’s a bit of visibility on the reality of CPI: The CPI increases that occurred in the past 6 months are partially the result of pass-through costs due to the summer 2008 commodity shocks that are only now being felt by the end-consumer. Consumer goods manufacturers and retailers have seized the opportunity of summer 2008 to increase prices after a decade of intense competition and price squeezes. Having successfully lifted this ratchet, and adjusted consumer price frames, they are not eager to give up those gains by heading into a price war. Also, retailers (like grocery and drug stores) are increasingly oligopolistic at the regional level.

    These trends have been reflected in profit improvements in major CPG companies (due to margins). The ability to charge consumers more, however, is hitting limits – further margin increases will come at the expense of lost market share. I would therefore caution against extrapolating 0.4% in February to 5% annually.

  14. Off topic, sort of, but anyone care to offer an opinion why the Euro has shot up in recent days?

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  16. Interest rates remain low so long as demand for debt exceeds supply.

    Demand can be provided by the Fed (by making money) or by domestic savers or by international investors.

    The downside to the Fed providing that demand is that it doesn’t take money out of circulation (like the other methods). Under normal times, this amounts to an inflation tax on currency-denominated assets.

    Money, however, is already being taken out of circulation due to deleveraging (e.g. credit contraction).

    Thus, we should not see CPI-style inflation until the deleveraging ceases (e.g. money Velocity is restored, or resumes an upward path).

    At this point, the Fed hopes to “mop-up” excess liquidity by stopping additional credit creation and calling in debts (essentially, sucking money back into the black hole from whence it came).

    As to the problem of controlling money velocity – absolutely that’s a problem, which is vastly exacerbated by the allowable amount of leverage in the system (essentially, the capital/asset ratios). It’s also a problem because, unlike the supply of base money, the Fed has few direct instruments to control the velocity of money.

    A long term solution might be pump in money but simultaneously reduce legally allowed leverage levels (e.g., update the Basle Accords). This would prevent an inflationary “rebound” when velocity recovers.

    One _could_ argue this is ALREADY being done as the ratings agencies reclassify mortgage-backed debt (CDOs) from AAA to lower ratings. Cap-asset ratios depend on the qualify of assets being held. If you hold a lot of high quality assets, you need less capital.

    However, with potentially trillions of dollars of debt-backed assets being reclassified as lower quality by ratings agencies, _effective_ cap-asset ratios are increased.

  17. So, are we back to the point where we can argue that 1) zombie banks need to be closed; 2) adding money to them hasn’t loosened credit markets because individual banks won’t act as rational actors for the whole industry; 3) the economic pain of doing it later will be much worse?

    Or shall we all collectively bury our heads in the sand a while more?

  18. It looks as though the BofA bandits are already making out just fine.

    http://brontecapital.blogspot.com/2009/02/series-of-quarterly-numbers.html

  19. $35 per barrel is below the cost of replacement production. There is temporary excess production capacity, but it’s only temporary. New production is being curtailed, and demand will ultimately recover (at least somewhat).

    Also, OPEC started to show a little leg.

  20. Can someone clarify what Simon mean by the follow?

    “But if the whole world is moving more into an emerging market-type situation “

  21. Economist Steve Keen convincingly argues that inflation is an extremely unlikely outcome — i.e., the amount of money that would need to be printed is much larger than most people (the Fed included) understand.

    As for commodities, it seems likely that the extreme spike mid 2007 to mid 2008 was driven in part by speculation (not just by financial entities but via accelerated buying based on expected price increases throughout the demand chain — IEA oil inventory numbers reflected only the large primary terminals not everything past that in the demand chain). While one could argue that this could occur again, short of wars or other massive supply shocks, it is probably self-limiting in the context of a debt deflation with global oversupply.

  22. Watching Bernanke on “60 Minutes” finally made me realize who he reminds me of: President Merkin Muffley in “Dr. Strangelove.”

  23. David Pearson

    Statsguy,

    Where is the evidence for credit contraction? The Fed’s Flow of Funds report shows 6% credit growth in 4q08. Even if you take out Treasury issuance, credit growth was (barely) positive. Are you predicting that credit growth will be negative in ’09?

    Of course private credit may contract, but its likely that public credit will offset it.

    I think there is some confusion regarding de-levering. Bank liabilities are not shrinking as they were in the Great Depression. Further, households are paying down debt, but this is offset by the public sector. Broker Dealers certainly delevered (massively) in 4q, but not enough to drive overall credit contraction.

    The Flow of Funds report paints a massive change in the composition of credit, but not in its level. The report captures the vast majority of securitized credit (mbs, consumer abs, corporate bonds, etc). It does not count (net) derivative losses directly, but then these would eventually show up as declines in banking system liabilities and presumably would be offset by further public credit growth (as the government provides further support for banks).

  24. Michael M Thomas

    Well, I’m both old-school and old, and I agree. What got lost sight of during the past fifteen years was that Glass-Steagall, margin, uptick etc. rules were instituted to forestall certain abuses and excesses. When these were taken away, can we surprised that almost exactly the same excesses and abuses occurred?

  25. How many things today are blocked because of high interest rates?
    .
    .
    .
    Bernanke’s latest is a desperation move that does not sync with his public statements. It is a bluff as far as internal US policy, but it is a dangerous move internationally because it undercuts other countries who will increasingly blame the US for their troubles.

    Bernanke and Geithner continue to try to keep an untrusted system afloat while screaming about restoring trust. It is getting so detached it is comical.

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  28. David:

    Obviously where the contraction shows up is in the consumer section and in the immediate mix of GDP the consumer is just over 2/3 of the economy.

  29. gaius marius

    I think there is some confusion regarding de-levering. Bank liabilities are not shrinking as they were in the Great Depression. Further, households are paying down debt, but this is offset by the public sector. Broker Dealers certainly delevered (massively) in 4q, but not enough to drive overall credit contraction. The Flow of Funds report paints a massive change in the composition of credit, but not in its level.

    that’s the great hope from the view i’ve come to, david pearson. if gov’t deficit spending (ie fiscal stimulus) can be sustained at levels that offset the contraction in private spending as private balance sheets are repaired over time, then the contraction in GDP should be quite limited. the government must borrow out of the banks the cash that the private sector is pushing there.

    without private loan demand, there’s really very little monetary policy (even QE) will accomplish. i don’t see the inflation threat short of an international run on treasuries. but the united states should be in a good position to issue sufficient treasuries to its banks and private sector in an effort to recirculate savings, and so not need to tempt a collapse in the dollar by trying to sell trillions overseas.

    the trick, i think, is that the gov’t has to stop issuing debt to bail out financials — this is not stimulative spending filling the gap left by increased private savings and so does not contribute to sustaining GDP, yet consumes private savings and so forces international sales/monetization/redirection of capital from other markets. leave the fed to liquify the banks and let the banks earn their way out of trouble with net interest differential over years, a la japan.

  30. This is the link to the data you are referring to:

    http://www.federalreserve.gov/releases/z1/Current/z1.pdf

    There has been a large drop in both household _and_ business debt, offset by government debt. A lot of the government debt, however, has been “filling holes” – that is, creating money to prop up money that is at risk of destruction due to bank failure.

    Household debt growth fell from >10% from 2002 to 2006, to -2% in Q4 of 2008. Moreover, Q4 involved closure of a lot of purchases (like mortgages) for deals that were sealed in Q3. If we project the trend into Q1 of 2008, it looks bad.

    Business debt has seen a rapid drop in growth rate, now just ever so slightly positive – not high enough to sustain long term growth unless replacement of depreciated assets is cash-financed (and where is that cash coming from when profits are shrinking?).

    Finally, in the early months of this year, the Fed allowed its balance sheet to contract slightly. So we don’t know that govt. debt has continued to offset private debt through Jan/Feb of 09.

    To be honest, I do not think we yet have all the info that convinced the Fed to pull the trigger.

    But you are right that I should limit my comments to “private sector deleveraging”.

  31. The price of oil quoted by the NYMEX is NOT the real price of oil. Very little of the oil that is delivered and paid for on a daily basis is traded at that price. The vast majority of all oil is traded directly between producers and refiners on long term contracts. Supposedly NYMEX futures on WTI are used by OPEC to determine contract prices but even that is open to negotiation. A friend of mine with contacts in the Kuwaiti Oil Ministry says that through all this, they have been getting $60 a barrel. Due to the long term nature of the contracts and how quick the price has changed, their price never had a chance to adjust.

    Bottom line, the NYMEX price is set on a thinly traded market that is subject to much manipulation by speculators first hoarding and then dumping oil. Dont be fooled by it.

  32. gaius marius

    sorry — i should’ve replied with this here.

  33. Japan applied massive quantitative easing during the 90s. There was no inflation. Japan was aware of the potential for inflation so they carefully kept it under control. Managing inflation is doable.

    Inflation is cause by excessive money supply. This the economy to lend and borrow. However, we are not lending nor borrowing. The multiplier affect of the fractional banking system is significantly diminished. This diminishing of multiplier affect completely dwarfs the trillions the Fed is printing. It will take time for confidences to return. Taking money all of the money supply should be manageable. In fact, the bigger thread is taking away the money too quick before economy is on it’s way of recovery. Many have argued that was what happen to Japan (beside the banking problem)

    Right now we have a financial crisis. We can worry about potential for inflation afterward.

  34. I believe if I’m explaining this correctly here is your evidence (http://research.stlouisfed.org/fred2/series/MULT?cid=25). The St Louis FED publishes the M1 Multiplier (see link). That’s M1/M0. It’s fallen off a cliff. The FED has exploded M0, and since M1 also includes all the money in M0, the M1 Mult should be flat to increasing. The only way this could happen is if money is going into the financial system but not getting used, which means its not getting lent out. I believe that is by definition a credit crunch. If you compute the M2 Multiplier (M2/M0) you end up with the same picture.

  35. gaius marius

    money is going into the financial system but not getting used, which means its not getting lent out.

    exactly. this is why mother government has to get in there and borrow it out. if they don’t, GDP is going to tank.

    fwiw, some of it has to do with banks fearing for their skins — but i suspect the bigger problem is that there are very few good loans to write. the kind of people who want to borrow now are the worst sort of credits; meanwhile, the best sort are paying off debt, not taking new debt out. private loan demand is going to be the monster issue of the next several years, i’d wager.

    also fwiw — i’d bet corporate borrowing retraces severely in coming months. corporates facing punitive capital markets are drawing down bank lines, hiding the massive contraction in small business credit. look at f.103 in the z1 — the massive dropoffs in financial asset acquisition and increase in liabilities for non-farm non-corporate business. once those committed lines are gone, it could be messy.

  36. To the Lighthouse,

    If what you say is true, that the real prices for oil didn’t change much, then why did the price of gas go up so much?

    Ed

  37. “the trick, i think, is that the gov’t has to stop issuing debt to bail out financials — this is not stimulative spending filling the gap left by increased private savings and so does not contribute to sustaining GDP, yet consumes private savings and so forces international sales/monetization/redirection of capital from other markets.”

    Yes, and yes.

  38. I think StatsGuy has it right – and I don’t understand why so few commentators get it. When the private sector banks are effectively reducing the money by not making loans, the Fed could be simply filling the hole in order to keep the real money supply/velocity equation stable.

    But I haven’t seen any quantitative analysis examining whether there is any balance between these factors, taking account of other monetary actions (like the bail-outs) as well. In other words, are the Fed’s levels even close to right?

  39. Nice graph.

    Can anyone explain the downward trend line from 1987 through 2000?

  40. Simon,

    What is your view of Steve Keen’s work and Niall Ferguson (http://www.niallferguson.com/site/FERG/Templates/ArticleItem.aspx?pageid=203)? Isn’t it true that there’s currently too much debt? How is the huge adding on really going have any hope of reflating things?

  41. To Ed:

    That is a good question. The price of gasoline did not go up nearly enough to pay for $150 oil. Yes, as hard as it is to believe, if the real price of oil had been $150, gas prices would have been much higher.

    Oil did get higher during the run up. I invest in a number of O&G companies and in their financial statements, they list the contracts they have on their oil production. Many of them were selling oil at $50 to $60 all during the price run up and they are still selling oil at the same price today. But some got lucky and had extra production and have lock in $100 oil for a year or so (although it is not clear that they will get all of that. Most contracts have clauses that allow for either party to void the deal if the price of oil gets too out of whack with the contract.) I did hear of people being able to sell some oil at $120 during the price spike but that was about it. I know of no one who refined $150 oil but I guess there had to be some. I do think almost all of that oil went into storage.

    My big issue though is with the WTI price at Cushing. That is the official oil price per NYMEX. Look at how it has behaved compared to the Brent price on North Sea oil or even Cushing prices on Louisiana (Gulf) oil. There has been a big discount in WTI relative to North Sea, sometimes as much as 25%. WTI almost never trades for a discount to Brent and barring specific political or environmental events (hurricanes, wars, strikes) you never see anything like 25% difference in the prices. The only reason for this amount of discount is manipulation of the specific WTI price due to speculation. The NYMEX price is not the true price of oil. It can not be trusted.

  42. Wow, thank you, this graph is very informative.

    There are a couple of note worthy points in this graph.

    1. the good news is the multiplier has probably bottomed on 2/11/09!
    2. it took 5 months to get here (fall off cliff on 9/10/08).
    3. psychologically it is much faster for human to become fearful than to regain confident.

  43. It is important to understand the world oil market is not really a market. N.A is dominated by small to medium producers pumping from aging fields. There is a real need for price discovery in such an situation and the N.A. market, leaving out WTI at Cushing, is a pretty fair market. But that is only about 45% of our oil needs. The North Sea due to the many jurisdictions involved in the field also has a real need for price discovery and that market is pretty fair. But in both cases, most of the oil is not traded through the market. The market is used to set contract prices and every contract is +/- to the market price.

    Every where else in the world there is no market, it is all contract. 85 million barrels a day, most all it traded dark, no price discovery.

    Daily WTI volume at Cushing is tiny compared to the 85 million a day and yet with all the ETF’s and other derivatives trading on that one price, we have that tiny amount of oil stand in for the whole worlds supply. It is crazy, just like a lot of other things going on these days.

  44. “…the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.”

    (From Bernanke’s 2002 speech). Ever notice the word ‘nominal’ before ‘spending’. Interesting word. You can, of course, increase nominal spending without increasing real spending at all. And what use is that?

  45. bewilderedandindespair

    Why can’t we rethink monitary policy period!!! It is a criminal offense to manipulate markets, unless you are the government!

    Our gov’s manipulation of the markets is so out of control, how could anyone ever forget and have enough confidence to “invest”–maybe with all this manipulation, investing in capital markets is an archaic concept! It is straight out, like a poker game to put money in capital markets–our goverment steps in and substitutes the cards any time they like!!!

    The most troubling signs for our markets is the idea that our Fed Chair went on 60 minutes, and our President is stopping in for a chat with Jay Leno!!!

  46. one explanation: “…Citing what he calls a “game changer” for forex markets – and for Europe in general – Jen has changed his hitherto bearish outlook on the euro and now thinks it’s more likely to see $1.40 next than $1.20… In his first big shift on the euro since “the start of the global financial crisis”, Jen says the prospective $750bn-$850bn “IMF arsenal” will effectively bail out Eastern Europe and the likes of Austrian and other European banks with large exposure to those regional emerging markets: The ‘EE-EMU Nexus’ has been the main reason for his consistent bearishness on the euro up to now. A massive IMF infusion would be “as much a bail-out for the likes of Austrian, Italian, German, Swiss and Swedish banks as it would be for Eastern Europe,” he notes:” http://v2.ftalphaville.ft.com/blog/2009/03/18/53715/a-game-changer-for-the-euro-and-a-coming-chf-bloc/

  47. we_are_toast

    That interview on 60 minutes really struck me. I thought I could see him tremble a few times. I kept asking myself, why is he doing this? He must be really scared that things are out of control and he’s trying to calm people down. I’ve seen kids going to the dentist look more calm than this guy.

  48. Adam’s first comment hit the mark: “The only way out of this is wage inflation and or writing off the bad debts, because that’s the real problem. ”

    I’d also add, that we need increased employment- along with wage inflation and the writing off of bad debts.

    Any inflation needs to “hit the streets” to be meaningful. Just increasing velocity by shifting the money between big players (banks, governments, etc.) won’t do a thing for the good of the whole.

    I believe we (in the US) currently have a Kleptocracy that is just one soep on a short ride to Fascism.

  49. TYPO: “soep” was suppose to be “stop”

  50. “any…have enough confidence to invest”

    Personally, one of the reason I invest is precisely because I can count on the government to step in when things get out of hand. I think the market would have been much worse off if the government didn’t get involve.

    Anyway, I believe this is built into the society’s expectation like gravity.

  51. it’s my impression that speculators and others drove up the price of oil because they saw no more easy money to be made in housing/derivatives etc. Oil was the last refuge of those scoundrels.

    And that drive up in price exacerbated the problem of the homeowners/consumers abilty to well, pay mortgages and consume useless goods.

    That’s how it played out in my view.

    Are we at peak production? sure, but not to the tune of 150 a barrel. The bright side is with low oil consumption, we may have enough left to get us through to the next invention of a comparable source of energy. (cold fusion or whatever)

  52. This is very interesting.

    This does sound like a great place to make money with arbitrage. Arbitrage will than reduce the disparity. I have a naive question. Why can someone sell the oil he brought with contract on NYMEX?

  53. Lower mortgage rate will make a huge difference to the affordability of a home.

    At 4.5% mortgage rate, it will only cost $500 for a $100,000 loan.

    The math of low mortgage rate and low housing price is making it very hard to justify renting for someone with a job. Keep in mind the worse unemployment projection is it will top 10%. There are still plenty of folks with jobs.

    On a related note, see this stat about housing sale in California which historically leads the nation.

    http://www.calculatedriskblog.com/2009/03/dataquick-foreclosure-resales-now-52-of.html

    I think ben bernanke is right about there are some green shoots.

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  55. Joe,

    You can not sell the physical oil until you take delivery of it but you can sell the contract that you just bought. And then there is all the voo-doo they do with derivatives on the contracts. If you have physical oil, you can sell a contract on that. I think that is what WAS going on with a lot of the storage in Cushing. Last year there was a boom in storage tank construction in Cushing and I think it was fueled by speculators who wanted to hold oil and sell futures contracts on that oil and then trade derivatives around those contracts. But I really dont know. This is my speculation.

    However, I am not the only one who thinks the crash in prices at Cushing appears to have been driven by oil coming out of storage as hedge funds and such de-leveraged. It would explain why WTI at Cushing got so out of sync with the rest of the oil market.

  56. So Warren Buffet is right. Right now it is the best time to a bank. Buffet’s point was that right now the interest spread banks earn is at an all time high. Furthermore, the new borrowers are high quality borrowers that are very unlikely to default.

    More green shoots!

  57. Green shoots from whose point of view? Seems to me that the US taxpayer gets little upside benefit from his very limited equity stake in the banks, is paying over the odds for his loans and receiving precious little interest on his deposits. Meanwhile the taxpayer is underwriting any future losses.

  58. Wow, this on top of the $500K salary cap. Why would any one wants to apply for senior positions in all the major US banks?

    I agree that something needs to be done about the AIG bonus. However, I am don’t agree with the incentives this creates.

    The traditional bonus is a reward for good performance is better system. Right now it is no bonus period!

  59. You are who you trade with.

    The US and China are averaging out.

  60. I am viewing this from the society as a whole. The sooner we can get the banking industry back to health (profit will help), than the sooner we’ll all get out of this crisis.

    Just think about it. Suppose we could get out of this crisis 1/2 year earlier because the banking industry recovers faster? How much total benefit are we talking about in terms of increase employment, higher tax revenue, gdp growth and etc. We can also consider this globally since the US economic engine can help pull the rest of the world out as well.

    How does that compare to the bail out money we’ve spent on the banks?

    To be honest, I worry very much that we are getting too much distraction from ideology and loose sight of the bigger picture.

    Lastly, I want to point out what I say above is independent of nationalization. Even if we nationalize trouble banks, a profitable bank will still lend more.

  61. we’ll be out of this by the ned of the year. soulshine is better than sunshine is better moonshine and damn sure better than rain.

  62. markets.aurelius

    What you’re proposing likely would require a major re-write of some important regs that paved the way for the massive leveraging of broker-dealers (BDs) balance sheets. Chiefly the SEC’s Consolidated Supervision of Broker-Dealer Holding Companies. To wit: http://www.sec.gov/divisions/marketreg/consupervision.htm

    This, by the way, was what Hank Paulson lobbied for in 2000 as CEO at Goldman. http://banking.senate.gov/00_02hrg/022900/paulson.htm

    This, btw, was a masterpiece of fear mongering, designed, ultimately, to get capital requirements relaxed and leverage ratios increased, which ultimately was very successful. (Maybe there’s a better way of phrasing that … Hank and his co-evals got to crank the leverage up and pile on the toxic waste that no doubt produced huge margins and mark-ups for the trading and sales groups, but they ultimately destroyed the whole system.)

    The SEC’s Consolidated Supervised Entities rules above were “… intended to provide consolidated supervision to investment bank holding companies that is broadly consistent with Federal Reserve oversight of Bank Holding Companies. The regime is intended to allow the Commission to monitor for, and act quickly in response to, financial or operational weakness in a CSE holding company or its unregulated affiliates that might place regulated entities, including US and foreign-registered banks and broker-dealers, or the broader financial system at risk. While maintaining broad consistency with Federal Reserve holding company oversight, the program is tailored to reflect two fundamental differences between investment bank and commercial bank holding companies: First, the CSE regime is focused on the daily marking-to-market of most positions as the critical risk governance and risk management tool at securities firms. Second, the design of the CSE regime reflects the critical importance of maintaining adequate liquidity in all market environments for holding companies that do not have access to an external liquidity provider such as a central bank.”

    There’s a lot that can be said here re how this fostered the recklessness that caused the meltdown of the financial system globally. And the demise of the investment-banking model. 3 of the 5 firms in this program (Lehman, Merrill and Bear) were vaporized, and the remaining 2 (Goldman and Stanley) are now commercial banks. The only fundamental difference between the investment banks and commercial banks now is the former no longer exist. So I guess that alone means the CSE program’s rules and regs would have to be re-written. But it was great while it lasted: The broker-dealers got everything they wanted, levered themselves massively, generated huge ROEs for a while, and then blew up.

    Here’s something to consider, which comes directly from the CSE program above: The SEC was — or was supposed to be — getting monthly reports from these BDs, which were supposed to flag material changes in the condition of these BDs in their positions and their counterparties’ positions. A post-mort on those reports — what the BDs said and who at the SEC and Fed were doing whatever they did with them — would be very helpful to our understanding of how we came to this point. When the hearings into this are conducted — if ever — it will be interesting to see how we went from Hank’s 2000 testimony to his recent op-ed in the FT, which looked a lot like remarks he made in March 2008. http://www.treas.gov/press/releases/hp897.htm

    I guess that’ll be Hank’s legacy: Fundamentally disabling the system for the short-term benefit of a few former investment banks, then coming in after the fact to tell us how things can be improved. That, and the fact that he was able to shield Goldman et al from an ultimate demise, by getting the US government to step in and fully cover AIG’s performance on CDS and other sundry derivatives they piled on to the BDs’ balance sheets.

    What an interesting time to be alive.

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  64. hyperpolarizer

    I am not an economist, and have no qualifications to vaunt — but will jump in by posing this question: if China (and other important lenders) become reluctant to lend to the US Treasury (by buying US bonds) will we then be forced to raise interest rates, despite the potential harm this could cause to a domestic economy already tottering?

  65. everytime i tey tey to pray,,,,something always gets in my way…..i am on my heaven. iam getting closure by the day. i can hear the angels pray. iam going to get there… are you?

  66. money aint the villan,,, it’s greed that’s the killer

  67. Greed is a force of nature, just like gravity.

    If a system doesn’t account for it than it is the system’s fault.

  68. Watching the 60 minutes interview couldnt help feeling that helicopter ben was feeling a little like the kid in the candy store..in his ability to test some of the concepts he had theorized years earlier would prevent another great depression. But it also feels like a bit of microsurgery by bazooka and that he’s testing them all at once and when mixed together who knows what the reaction will be. I’m sure he thinks policymakers have the tools to mop up this massive amount of new paper in circulation when they see the need…but how will they know that that before its too late…fearing not making the repeated japanese mistake of shutting down the rocket to early to reach terminal velocity…by definition wont it be too late by the time its apparent to mission control that we have liftoff?

  69. Indeed!

  70. Steve Keen has the mathematical side of things right. The economy is a complex, dynamic system with many variables and interactions. Alas, differential analysis is beyond our current crop of frantic lever pullers like Bernanke and Geithner.

    There’s another part of dynamics I wish Keen would address: chaos theory. That’s when extreme inputs into a stable dynamic system cross a threshold the system spirals off into wild, multidimensional patterns. When applied to underlying physical systems, it often means things break or explode.

    Then you don’t have to apply the equations to the system because, well, there is no system anymore.

    Perhaps we are seeing the first effects already: price inflation and volatility, wild swings in currencies and equities. I suspect that is only first orbit on the way to total discombobulation.

  71. “Also, interest rates are low by historical standards and it hardly seems to be stimulating much.”

    Nominal rates are low, but what about real rates? Isn’t that what matters?

  72. In the previous paragraph to the one you question, Simon writes: “If inflation is driven by the so-called “output gap,” i.e., how far the US economy is below potential output, then prices will not increase much…”

    One question then is why does Zimbabwe have inflation? They are obviously below potential output so prices shouldn’t increase that much (according to the statement).

    Now read the next paragraph and it should make sense.

  73. perhaps something to do with this as well: “…OAO Sberbank, VTB Group and other commercial banks have stockpiled more than $100 billion to help companies refinance foreign loans and the government will only offer direct aid in “extreme cases,”… Russian companies… owe foreign banks about $100 billion this year… “The government’s position on Russian debt to foreign banks has been that all debt must be paid back and all agreements upheld,”…. That means the government may not object to foreign banks taking stakes in companies such as Rusal if that’s the best way to repay debt…“This $100 billion not only belongs to the banks but to companies, because they asked the banks to buy them foreign currency to develop a sizable foreign exchange cushion for their repayments,” said Yulia Tsepliaeva, chief economist in Moscow at Merrill Lynch & Co. “This was part of the plan, the government wanted the banks to build this cushion.” Russia isn’t interested in bailing out companies “as often as some of our foreign partners… We are viewing it with great caution and would like to avoid state acquisition of assets if possible… We believe in private initiative.”…” http://www.bloomberg.com/apps/news?pid=20601109&sid=auoHi6cJv0TA&refer=home

  74. if the bigger worry may be a failure of reflation: “…After surging above $51 a barrel the previous day, oil prices drifted back Friday in Asia as traders reevaluated expectations for renewed crude demand amid persistent uncertainty about the global economy…” http://www.boston.com/business/articles/2009/03/20/oil_drifts_back_as_trader_reasses_outlook/

  75. Young Economist

    Why FED distorts risky-asset prices to reduce risk premium create more severe deflation and more economic contraction and Why FED addicted to expand more intervention by printing?
    1. Distortion of risky-asset prices relative to riskless assets by FED will cause investors’ preference shift from investing less in risky asset from lower required rate of return than that private can accept into investing more on riskless asset from higher relative price. This is why Japan failed to create the growth from Quantitative easing method.
    2. Private sectors will shift more money into riskless assets and sell more risky assets from the lower distorted prices by FED and meanings that the first Quantitative easing method is not working. I mean currently we see all assets are priced in from FED actions both long bond yields and US dollar, but from now, the yield will move higher again from preferences shift of investors and US dollar is also appreciating again. Next FED is forced to use more Quantitative easing and at the end FED are addicted to print more money to buy nearly all risky assets and economy is not picking up and price is also deflated.
    3. The main concern is if FED stop using Quantitative easing or there is the shock (like corporate default), that will create reversal of risky-asset prices and there will be massive loss to the investors joining with FED to hold those distorted-pricing assets; surely, this system will collapse to change the recession and the deflated price to the great depression and the severe deflation.
    4. Therefore, FED action to support asset price is wrong and they can bail out all private investor and speculators in financial market but they definitely cause all people to face the disaster of economy.
    I am still confident that the intervention is disaster for economy because it just transfer loss from the specific investors in Wall street into every people in the country; however, not everyone prepare for the loss that FED have done, so total social loss will be more massive than letting Wall street investors lose.
    Only way to solve this crisis is that FED and US government should build the system and policy to ensure that if no intervention or market-distortion policies, the economy can sustain the growth whatever high or low in the long run.

  76. Clifford Nelson

    I am not sure where real rates are given the last inflation numbers, but I think there is a point of diminishing returns and higher costs in the fed’s purchases. That is, the more it spends the less we get …. as the dollar drops. Anyway, have a nice weekend. Also, a lot of the money went to buy mortgages and drive down rates, but mortgage interest is tax deductible so the real savings (in terms of putting $$ into people’s pockets) is even further compromised.

  77. Here is my take on the oil price bubble of 2008 and the prospects of commodity inflation in the near term.

    Sure oil prices surged upwards in the face of a slowing global economy in 2008. But then the surging oil prices arguably triggered am acceleration in the decline of global GDP, which caused oil prices to tumble to levels below where they started.

    I think the same dynamic will choke off any inflation in assets or commodities. Investors scared of inflation will pile into a commodity or asset, drive its price up through the roof, then the high price of that asset/commodity will start kill demand (like happened with oil) and drive businesses and households into the ground (like happened with oil) and the price will tumble in parallel with the economy diving deeper into recession.

    The only way to avoid this dynamic is if income and profits are rising at a fast enough pace to allow people to pay the inflated prices. Is that likely in the next year or two?

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  79. Technically speaking that could happen, however…

    A) The FED has already committed its printing presses to the treasury market. It would just need to commit more to take up the slack.

    B) China really doesn’t have any other choice but to buy treasuries – in the short run. For all of China’s recent complaining, they wont or cant move away from US assets and considering how all other assets markets are currently behaving, treasuries are still safe havens. While China keeps talking about diversifying out of US assets, in the short run to do that would risk appreciating the Yuan to the dollar and with their exports already in the toilet they are unlikely to make such a move. They can’t have their cake and eat it. There are no free lunches in economics.

  80. With regard to inflation stimulating home buying, the thing that has really struck me as odd about the discussion of the housing market and prices is that no one seems to talk about the physical supply of housing as it relates to population. If there is more housing in America than the existing population needs for shelter at historical occupancy rates, then no amount of lowering mortgage rates or creating inflation will prop up (inflation adjusted) housing prices. I did some rough calculations on my blog, and it looks to me like we just have more housing units than our existing population can use, which to me means that nothing is going to stop the decline of housing prices in the near term.

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  82. To the Lighthouse,

    I don’t know a lot about commodities trading or markets, but I have picked up snippets here and there from different economists on the Internet, Simon Johnson also(I think) and from a Marxist economist named Peter Gowan over at Monthly Review that the oil and gasoline price rises in summer, 2008 were entirely or mostly created by hedge funds and other speculators, would that be a reasonable statement to make? Your comments seem to point that way.
    Thanks for your comments on this topic, by the way.

    Ed

  83. The problem with using a fear of inflation to get investors to shift out of cash and into assets is what happens when the fear of inflation vanishes? If people shift into an asset out of fear of cash losing value, and not because of the asset’s perceived future income potential, then once inflation stops the asset is going to suddenly look like a dog and people are going to exit.

  84. Simon and James please consider a post on the role the Fed is taking in the current crisis. What do you think of their programs, guarantees, and seemingly unlimited power to increase taxpayer liabilities? Most support an independent Fed, but should there be some broad limits on their powers? It would be intersting to hear others opinion on this.

  85. There’s a picture of the $:Euro exchange rate at 5 minute intervals in the 3/19/09 Wall St. Journal. The Euro was flat until the minute before the Fed announced its intention to buy long-term debt. Then it changed by a couple of pennies in a minute. (Oh, to have had insider information on THAT one!)

  86. Charles R. Williams

    Velocity always falls as the initial response to expansion of the money supply. We should see inflation pick up in the second quarter.

    How is stagflation possible? Very simply, if you grossly mismanage the real economy while increasing the money supply, you get Jimmy Carter style stagflation. It is possible to hit the accelerator and the brake simultaneously. If you do, the engine revs and the car goes nowhere.

    The Obama administration has initiated a permanent, massive expansion in the burden of government on the economy which will be paid for by huge tax increases on the most productive and energetic people. The rational response on the part of people in a position to save is to increase their savings further. And higher taxes will lead them to do this by reducing consumption rather than postponing retirement or having both spouses work.

    Bush-Obama bailout policies will make it impossible to fund the draw-down of the Social Security system. Prudent and insightful people will cut consumption.

    There is the impact of inflation on vested pensions and other dollar-denominated assets. Another reason to save.

    We will see large numbers of highly-skilled immigrants return to their homelands as opportunity evaporates in the US and the Asian economies recover. This also will depress the real economy.

    Finally, there is the Peronist-style demagoguery of the news media and the Congress. Threaten the sanctity of contracts and you turn America into another banana republic.

  87. Simon’s question — If oil prices jump, then we have an even bigger inflation problem. Oil is not storable, supposedly. But if you can explain to me exactly why oil prices rose as they did during the first part of 2008, despite the slowing global economy, I might be greatly reassured that we are not heading immediately into a runaway inflation spiral.

    I will try to answer. Oil prices had been rising steadily since 2003. If you did a curve fit, as I did in the 1st half of 2008, oil would have come in at about $110-$115/barrel according to supply/demand fundamentals. You should know that world oil production declined year-over-year in 2006 and 2007 (EIA data). You say a “slowing global economy” but oil demand in the emerging economies (outside the OECD) was still quite robust. Importantly, the oil price was driven by demand for middle distillates (diesel, jet fuel, etc), not gasoline. Emerging economies are still quite dependent on diesel fuel in ways that advanced economies are not.

    So if the price should have been in the range stated above, then we must account for another $30-$35/barrel (at the high point). The added premium was caused primarily by 1) the slack dollar and 2) speculation in the futures market.

    What could happen this time? If global demand is way down — it is — then there is at least 3 million daily barrels of spare capacity out there (all in OPEC). If printing money boosts inflation, we will see modest price rises based on the usual rule (oil is traded in dollars) but nothing like the surge in price we saw in late 2007/first part of 2008. For example, the imports/exports drop in China will not be undone anytime soon.

    I wouldn’t worry too much about a big increase in oil prices in the next few years. If you do see one, you will know that something isn’t kosher about the price.

    best,

    Dave

  88. Funding the draw-down of the social-security system is essentially impossible without significant changes. The Boomers borrowed too much, saved too little. Various small changes – retirement age, adjustments to Medicare part B, etc. – are going to be required to keep it solvent.

    I suspect Team Obama is sensitive to this issue.

    As to management of the other aspects of the real economy – it seems the Obama administration should get better marks than its management of the fake economy (e.g. finance).

    They are right to target the medical system; we have a system in which (whether you like it or not) the emergency room has become a public health system. In which we overdiagnose and overtreat, with little concrete proof of effectiveness. In which other countries pay far less than the US for the same drugs (which were developed in the US). In which GPs are underpaid and overstretched. In which the costs of pursuing payment, managing the system to prevent non-payment, and negotiating payment levels have created real burdens on everyone – even though we have proven incapable of denying treatment in many cases for those that cannot pay. And, finally, in which the private insurance system is incapable of making rational decisions between million-dollar end of life care and providing less expensive prenatal care – simply because hospitals are compelled to chase profits.

    The argument for letting the profit motive drive the entire health care system was that it would give us a better (and more disciplined) system, yet there is no evidence to that end, and mounting evidence that the opposite is true. While we do see some excellent private sector innovations (health clinics in drugstores and Walmart), the health care system is _inherently_ plagued by incredible market distortions:

    - Asymetric information
    - non-rational behavior
    - individuals who are non-functional (dying, senile) making complex “decisions”
    - bargaining inequities/oligopolies (insurance companies pay much less for identical services than individuals)
    - both adverse selection and moral hazard in insurance contracting
    - previous non-market attempts to ‘fix’ the system that were patched over 70 years, now creating huge competitive disadvantages for US firms

    Team Obama has also targeted energy, environment, infrastructure, and education as primary areas for additional investment. And they are right across the board. To place your faith _entirely_ in the profit motive and sanctity of contracts to mobilize the US economy to fix drastic problems within a decade is entirely unrealistic.

    The baseless and unchallenged faith in the profit motive to _always_ work has allowed grossly anti-productive behavior to continue unchallenged.

    Consider one example of how the profit motive increases economic “growth”:

    Company X is a mining company. In order to keep costs down, the Federal govt. relaxes effluent and emissions controls (turns out the agency in charge has some bribery and sex scandals, but heh, who doesn’t these days?). Company X generated $100 million in revenues and $20 million in profits over 10 years, until the mine is played out. The wages and profits are then recycled into the economy, and it looks like we have a lot of growth.

    Unfortunately, after the mine distributes its winnings, it closes down and declares bankruptcy – leaving large unpaid environmental debts. As with the financial sector, it’s virtually impossible to recover profits that were already distributed over 10 years prior to declaring bankruptcy, even if you can win the lawsuit (a costly and time consuming process). And even then, the total profits generated would not come close to covering the cost of cleanup…

    Destroyed waterways, arsenic and slag-tainted soil and underground water supplies, and a littany of health problems among employees (and even non-employees in the vicinity).

    The “economy” then “grows” because the govt. has to pay for health/end-of-life care for disabled workers. It also has to pay for cleanup. And for this, it levies taxes.

    In this sense, official GDP number grew twice – once from the damage-causing activity, and again from repairing the vast amount of damage. But are people better off?

    One of my great feats regarding the financial crisis is that Team Obama’s incompetence at handling it would cause collateral damage to its other initiatives, which are much more sensible.

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  90. markets.aurelius

    This M1 Multiplier would appear to be a better measure of velocity than the old nominal GDP/Money Stock.

    I think it’d be useful to plot the PCE/DPI ratios with your M1 mult’r. They appear to be mirror images.

    http://www.bea.gov/national/nipaweb/Nipa-Frb.asp

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  92. There seems to be too much uncertainty and too many *ifs* (e.g., If inflation is driven by …, if the whole world is moving more into an emerging market-type ….., If oil prices jump…..). Is there anything out there that we (the majority of concerned citizens) *do* know that will most likely happen given the current course of events, the Fed, banks, bailouts, $velocity, etc.? What is the worst/best likely outcome? How soon?

  93. David Nowakowski

    Econ 101: Please draw supply and demand curves. For oil, the curve eventually gets very steep: more demand can’t produce any more oil quickly, but causes extreme volatility as the price can skyrocket. Demand was very high through early 2008 (OECD total GDP peaked in Q2-08!), the dollar was weak, the Chinese were not just doing their last Olympic push but both the US and China were adding to their stockpiles.
    Of course in any market there will be some who try to forecast such trends and get in front of them. Back in 2006, it was public pension funds and endowments that rushed to add exposure. By late 2008, many hedge funds were getting killed on collapsing commodities: why doesn’t the public blame them for pushing oil too low?
    In a nutshell, the reason for high oil prices (still very high today at $50 — 92% higher than in Jan-2000) is in the mirror.

  94. The commodities markets are a potential source of the next wave of the crisis because of the ratio of the volume of market to the volume of commodities.

    The economists warned that the situation is dangerous enough when there were 10 times more commodity derivatives than commodities. Currently we have the market when the total value of sold contracts is approximately 100 to 1000 times greater (by different estimates of different professional participants – what’s the real figure I wonder?) than the total value of commodities produced. And while only 5 to 10% of the contracts give a buyer the right to request actual delivery, it is still at least 5 times more than the volume of actual goods.

    So the speed of possible inflation and negative consequences is limit only by governments’ intervention to control prices and distribution directly. But as current crises shows governments are always too slow to react and worry much more how their actions look than about consequences.

    When investors realize their commodity derivatives are worth significantly less than multi-layered structured sub-prime mortgages (which means “nearly nothing”) the current crisis will seem just small waves on the surface compared to the storm that will follow.

    But all the companies exposed to these risks, investment banks and governments prefer to stay blind to this problem.

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