The Dismal Optimist

You have to be impressed with the style and content of Obama’s three press conferences last week when he introduced his new economic team to assist him in quickly developing his new economic program. Also impressive is the caliber of the personnel he has chosen-they are all heavyweights with strong personalities and largely centrist in political ideology.

Obviously, it is Obama’s intention to operate his various teams in a collegial manner so that controversial issues can be thoroughly vetted prior to reaching his desk for decision This is excellent strategy considering Obama’s lack of major league executive experience. Certainly a new program is badly needed. The economy has come to a full stop and recovery appears uncertain. There is a widespread fear of a global Depression and that the age of prosperity is over.

It is interesting to note how history, or divine intervention, sometimes brings to power a different kind of leader to launch a new paradigm of growth and direction. Hopefully, Obama proves to be such a leader; he certainly has the good wishes of people around the globe.
Yet, for Obama to succeed in whatever scheme he chooses it will, dangerously, require huge sums of investment capital from the Federal Reserve with delayed returns of revenue in the initial stages of operation. This hurdle is an immediate threat on taking office because of failed or misused policies of the Federal Reserve regarding inflation, the Fed Funds Interest Rate, and the monetary base. All of our current problems stem from the fact that the Fed’s inflation policy has been a failure and an entirely new approach is urgently required. 

The RAM Equation of Zero Inflation.

The Gross Domestic Product is expressed in two forms. The first is in current dollars GDP1, and is the cost of payrolls for the labor used in the production of the goods and services.(GDP1). The second is GDP2 which is a deflated value of GDP1.. The calculation is simply the division of both GDP values by the payroll employment value. A calculation using 2007 values follows: 

Employment (millions)	GDP1(millions)	GDP2(millions)
138.002	13.844	11.567
Output per Employee (thous.	100.30	83.66

 

 

 

 

 

The demand/supply inflation equation: GDP1-GDP2/GDP1 (100.30-83.82)/100.00=16.4% 

Zero Inflation occurs when the output of GDP2 equals the output of GDP1 

The True Cause of Inflation Is Productivity. 

The fact that Zero inflation is now readily attainable opens up several new and important operating horizons for the full Federal Reserve organization. It is ideally suited for the task, with its’ national geographic structure and very professional staff, to develop and coordinate the productivity effort of 140 to 150million employees in hundreds of different sectors of the complex U.S. economy and streamlining the total effort with Congressional, State, Administrative and Regulatory Authorities. A very big job indeed but with very big returns. 

Most of the benefits that accrue from such a national effort will certainly be a giant step for the success of the new Obama paradigm. Some of the others will be: Global competiveness will definitely be improved; the value of the currency will be preserved; wages and salaries should increase; employment should be more stable with fewer recessions; prices will be more stable; international trade will be more balanced; in short a more confident future.

RAM/05/11/2008

The optimist ambled around the Upper East Side of Manhattan with no particular itinerary. Bringing a camera, he wanted to document in a very unscientific fashion, retail store closings and price reductions. Pictures were taken Wednesday November 20. There were a lot of closings and some price discounting even though the Christmas selling season has(d) yet to begin.  

 

 The biggest closings were Circuit City and Talbot. Gothic Cabinet - a low end furniture store and Barnes and Noble were consolidating nearby stores. 

 

Yet, equally important in our view was the consolidation  of a redundant Barnes and Noble on  Lexington between 86th and 87th into the B&N on 86th between 2nd and 3rd. 

 

There were a number of stores like Victoria Secret and Footlocker which seemed to be stacked, floor to ceiling, with merchandise. Yet, next door, Strawberry and Steve Madden had significantly discounted most of their merchandise.

 

The culling of major retail locations on the Upper East Sidee has been going on for sometime.  Some properties like Talbots have been closed since the summer. Presumably these reflect weakness in product appeal within the weak overall economic environment. It isn't a surprise that this kind of retail property.

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Nevertheless, the hardest hit stores seem to be small retailers.  

 

 

Yeah, but we need clear thinking. 

While I agree with the conclusion of Aslund, an economist at the Petersen Insitute, the lack of strong analytical thinking makes the optimist cringe. Comparing Friedman’s 20/20 hindsight criticisms with Keynes front line perspective is simply absurd. Compare Friedman and Galbraith if you will. Next, the notion that the twenties were a period of securities markets transparency is simply untrue. Stock market operators of the time relied on non transparency in stock market transactions to manipulate securities prices in an outrageous fashion. Joe Kennedy would famously march through the floor of the exchange driving prices up to set up crushing short sales.

Perhaps the biggest problem in the thirties was the state of mind. Policy makers stuck to sound financial principles — a strong dollar and balanced budgets and lead the economy straight over the precipice. “(T)he Federal Reserve and US President Herbert Hoover for their policies during the Depression, but at least they were policymakers and stood for principles.”

The reason why it could be worse this time around and it could is because “our policymakers are not likely to repeat the same mistakes of the Great Depression, but they may commit other mistakes”. This has almost certainly happened already. The commitment to AIG strikes me as having created a black hole into which the entire $700 billion in the TARP program could disappear with no benefit to the taxpayer or counter-party financial institutions security. Also, a slow recognition of deflation as the principal risk to to global economic activity also harmed the outlook because so many tools of monetary policy, interest rate policy, use of the fed balance sheet, use of FDIC guarantees have been maxed out already. With so much “assistance” already extended — and a two front war still raging — the Treasury needs in the bond market will begin to consume some of the liquidity waiting on the side lines.

An article from the FT By Anders Åslund

"This is the worst global asset bubble and financial panic since the Great Depression of 1929-1933. Still, almost all argue that it cannot become equally bad, because we have learned those lessons.

Analytically, that statement does not hold. True, our policymakers are not likely to repeat the same mistakes of the Great Depression, but they may commit other mistakes. Bank deposit insurance has come to stay for good, but not all advances represent progress, and many create new vulnerabilities.

One 1930s mistake was to defend exchange rates by all means. Today, most exchange rates float freely. Right now, we are seeing an unprecedented US dollar surge, which is not warranted by fundamentals but reflects a desperate search for a safe haven. The new hazard might be excessive and destabilizing exchange rates fluctuations caused by financial panic. Then, the major financial powers need to intervene to stabilize exchange rates.

Milton Friedman attacked the Fed during the Depression for allowing the nominal monetary supply to contract sharply, and John Maynard Keynes argued for more public expenditures through budget deficits, while the prevailing policy was budget surplus. The monetary expansion and budget deficits may become excessive this time.

With $700 billion in treasury rescue plan loan guarantees, injections of trillions in liquidity worldwide from central banks, isn't the yield curve likely to steepen dramatically?

The $700 billion in TARP will have to be financed by new issuance of treasury debt -- presumably as an exchange transaction for the toxic securities on books of qualified companies.  Or, it could be financed in the normal course of treasury debt securities issuance.  We just don't know what the shape of the plan is going to be.  If cash payments are made to purchase toxic assets, there might be lags which could be inflationary - but presumably reviving a poisoned economic patient is not the same as birthing a clone.

Multipliers, Multipliers -- Everywhere.

It seems to me that the notion of leveraged multipliers to fiscal policy is nowhere near as critical as the reduction in potency to monetary policy in the current crisis. Bank hesitancy to lend against bank reserves has had a contractionary impact on the money supply at faster rate than the injections of liquidity from central banks can offset it. During less extraordinary circumstances the trillions in liquidity injected into the  system, all agree, would be disastrously inflationary. Yet, risk averse behavior in the banking system seems to have overpowered whatever confidence building measures the Fed has undertaken.

Today all eyes on on the FOMC meeting today at 2:15, where traders are looking for a 50 to 75 bp rate cut to 1%-.75%.  In the view of the Optimist, this cut may have very little impact in resolving the economic consequences of the credit/housing/derivatives collapse. 

We are rapidly approaching a liquidity trap in terms of monetary policy as expectations of asset and goods pricing deteriorate faster than policy makers can lower rates. In short, monetary policy - in terms of interest rates is actually contractionary. The Fed's other actions  -- flooding the system with newly printed money and providing extraordinary guarantees to consumers is expansionary (and in other conditions disastrously so), but bank reluctance to lend also has a far greater contractionary impact. While this effect may be transitory, the money multiplier is contracting faster than the monetary base balloons upward.

"Deflation risk

There are plenty of things to worry about in the current economic situation. But deflation isn't one of them."

 Professor James Hamilton, Econobrowser.com

Professor Hamilton writes a blog I highly recommend but

The economic and financial outlook  is really quite dismal more intractable than I think most academic economists realize. It seems to the dismal optimist that deflationary expectations will soon begin to take root in consumers and investors. So yes, big time, world wide deflation is upon us...