The US economy is facing a challenging time for which Americans can thank the Fed's appalling monetary mismanagement, not to mention the lousy economics of the economics profession that is telling us that what the Good Ol' US of A needs now is damn good dose of inflation. In the meantime the Obama administration's spending spree would shame a bunch of drunken sailors. At least sailors spend their own money.
Obama is not only going to spend the earnings of the present generation of Americans but also their grandchildren's earnings and probably their grandchildren's as well. Come to think of it, the way his atrocious spending mania is going future Americans might not have much of an income to spend. (I am still getting emails from Obama cultists telling me that Bush is making him do it). Bernanke's disgusting monetary policy is building up a massive head of inflationary steam, symptoms of which are already making their presence felt. For some months now the prices of long-term treasuries have been trending down, meaning that yields have been rising. People who bought treasuries last year have suffered significant losses. I think even more losses are on the way.
Last week China and Russia publically declared that they are taking steps to diversify their foreign currency reserves, code for dumping dollars. Who can blame them? Under Obama American finances have become a total mess: deficits are absolutely massive and unsustainable, government spending is out of control, debt is rocketing while monetary expansion is unprecedented. This is a sure-fire formula for rising interest rates and accelerating inflation.
None of this fazed the media Pollyannas who reported that last week's 30-year bond market auction was a success and signalled the beginning of an upward trend in bond prices. These commentators overlooked two vital points. About half the bonds were bought by central banks. A clear case of collusion that cannot be maintained. The second point is that when inflation starts to accelerate bond yields will have to rise. There will be no stopping them unless the Fed decides to withdraw all those greens it printed. Not very likely.
The principal problem is Bernanke's vulgar Keynesianism. (I think the major difference between Keynes and today's Keynesians is the same difference between a social drinker and a dipsomaniac). Despite the historical fact that forcing interest rates down below their market clearing rates does not bring lasting employment and a permanent boom central banks still insist on doing it, egged on by academic economists.
Mankiw is right to point out that Bernanke is targeting inflation. But it's the only thing that Mankiw got right as evidenced by his view that "the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative... " Apart from the fact that it is impossible to target the rate of inflation Mankiw's prescription would make for more unemployment in the future.
Even if interest rates became sufficiently negative to generate an expansion in production and an increase in the demand for labour the resulting 'recovery' would be unsustainable. Prices would rise as would interest rates. The dollar would come under increasing pressure and balance-of-payments problems would emerge. The Fed would find itself having to slam on the monetary brakes again.
As for government borrowing raising aggregate demand, which is what Obama's supporters are claiming, this is plain nonsense. Genuine borrowing always means a transfer of purchasing power and not an aggregate increase in purchasing power. Of course, when government borrowing is funded by monetary expansion then total purchasing power in terms of dollars does increase. We call this inflation.
The borrowing angle that critics of Keynesianism are using to condemn Obama's reckless borrowing is sound economics but still misses the point. Keynesians argue that borrowing in a recessions does not crowd out investment because of the existence of idle resources in the form of unemployed labour and capital. The critics respond that the crowding out occurs when taxpayers find they have to fund the interest repayments on the loan. Moreover, there is no guarantee that the projects on which the funds were spent will not involve future economic losses that will have to be made up out of increased government spending which means either more borrowing, higher taxes or both.
Although this criticism is sound it cannot capture the full picture: that requires capital theory. Even where the government engages in genuine borrowing this could still seriously damage investment even if there exists a significant amount of idle resources. It can do this by directing expenditure toward consumption instead of investment. If one looks at the so-called boom of 1936-37 one will see that most of the expansion took place in the consumer goods industries while the capital goods industries badly lagged. (And it was the capital goods industries that won the war despite the level of capital consumption during the 1930s).
But of course we have to deal with Bernanke's reckless monetary policy. When monetary expansion is used to fund government spending crowding out occurs when the increased spending raises the demand for consumer goods and thereby attracts resources from the higher stages of production which in turn shortens the production structure. We call this capital consumption.
As a rule new money enters the economy through the capital market as a result of interest rates being forced down. This results in a disproportional increase in the demand for capital goods because the further away the capital good is from consumption in terms of time the great will be the effect on its value as the discount rate falls. This results in greater investment in more productive but time consuming projects that ultimately increase total output. We call this the "Wicksell effect".
We have now returned to bond prices and interest rates. Because the long term rate is rising -- and is expected to continue to rise -- we should not expect to see an expansion of investment in more productive though more time consuming projects. Should long term rates continue to climb the distinct possibility of capital consumption in the higher stages of production could emerge.
Whichever way one looks at it Obama's economic policies are -- at the very least -- a recipe for stagnant living standards.
