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September 26, 2011


Backing the Fed and monetary policy is like watching your horse come in last in every race and still putting money on it in the Derby.


It is often claimed that the Federal Reserve has a dual mandate. Indeed, there is such a thing in law. The Humphrey-Hawkins Full Employment Act of 1978 established full employment and price stability, along with requiring the Fed’s Chair to report to Congress and a list of other things designed to bring the Fed back into concern with the real economy.

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But as soon as the ink was dry, the Fed was back at work, not promoting full employment, nor price stability. Then, as soon as Carter’s presidency turned into Reagan’s, the Full Employment Act became a footnote. What survived was basically the mandatory appearances before Congress by the Chairman.

The Fed sees its single mandate neither as price stability nor full employment, but protection and encouragement of the banking sector. There is little room for debate on the point. The Fed is a captured regulator. Its concern with inflation is not concern for inflation, but concern for the returns on fixed rate investments.

Ben Bernanke was brought on board largely because of appreciation for his work on the Great Depression, which he analyzed forty years after the fact as primarily the result of not protecting the banks. The past four years of aggressive monetary policy, massive guarantees to bank credit, wholesale purchases of shoddy mortgage-backed securities and other direct if secret support to banks and quasi-banks, ahs been a test of Bernanke’s hypothesis. The result four years on? Hypothesis rejected. Bailing out the banks, holding their managements and creditors harmless, shifting trillions upward in the wealth scale, has not prevented the Second Depression.

We didn’t mean to get off on this, but the manifest failure of monetary policy illustrates the manifest ineptness of the Fed and its governors.

Maestro Magoo, Alan Greenspan also protected banks and markets to the exclusion of full employment, never shrinking from massive liquidity injections when things were rocky for markets. “The Greenspan Put” became the aggressive stock pickers ace in the hole. Greenspan would never let markets fall. But they did fall, late in the 1990s, and soon after we got Greenspan’s Put Two, 1% interest rates for years to jinn up a housing bubble. Previous to Greenspan, the now-venerated Paul Volcker made his reputation by sacrificing millions of jobs on the altar of low inflation. Volcker’s hypothesis, actually Milton Friedman’s hypothesis, was also untested: “Inflation is always and everywhere a monetary phenomenon.” Turns out, didn’t matter how you squeezed the money supply, inflation continued until you shut down the economy.

And on back to the Treasury Accord of 1951. Excess interest payments as a result of Fed favoritism to the banking sector and rentiers were, by the accounts of Leon Keyserling, the economist who led the transition from War to Peace under Truman, were tremendous even prior to 1980.

So when you hear, “the Fed targets inflation,” realize the Fed and its version of monetary policy are chosen not because they control anything, but because they serve the purposes of the financial sector.

So we should expect them to have a good idea about inflation. Right? No they don’t. That’s apparent by the wide diversion of opinion on their own self-selected Board.

Inflation and unemployment are the two horns of their dilemma. That is indisputable the way it is characterized. Raise rates to fight inflation. Lower rates to boost the economy and fight unemployment. Do I hear anybody who disagrees that this is how they work it? Basically a roomful of people operating a toggle switch? No.

It hasn’t worked, it won’t work, it can’t work.

Three years after the collapse of inflation with the collapse of the last commodities bubble, the central bankers are still running out their inflation horse. There is conflict at the fed, sadly, not about what to do about deflation or unemployment, but about how not to do anything more aggressive because of high inflation. As if…

And inflation, we assure you, is the subject of today’s forecast.

Unemployment is the cancer in a diseased economy. Inflation is body temperature. Or blood pressure. The two are not alternatives. One is a disease. The other is an indicator. To manage an economy to stabilize inflation without regard to what is going on with the patient is like forcing the blood pressure down or up to a medium level whether the patient is vigorously exercising or comatose.

What is inflation? First:

Is there inflation? No. There is no inflation. There is deflation. House prices are deflating, labor prices are deflating, investment goods prices are deflating.

But core CPI is on the uptick. Headline CPIO is going up.

Inflation is properly defined as a rise in the general price level. Core CPI, Headline CPI, PPI are the aggregate of many prices. So 95% of prices could be going down and one could be going up, dramatically, and the official measures would record an increase in inflation, CPI, or PPI.

Which is what we have. Here is Chad Moutray, chief economist at the National Association of Manufacturers, when he lets the cat out of the bag at a recent presentation at the National Economists Club.

Yes, the rise in producer prices is due exclusively to a rise in industrial commodity prices, we suggest as a result of financial market speculation.

Bottom line, we don’t have a rise in the general price level.

Here are our predictions anyway, for core inflation, all items, health care and energy components. Making sure you understand our point, that these are the indicators of prices of different sectors, they are not general inflation. Putting them together and adding them up does not necessarily approximate inflation.

(click on above image for expanded view in another screen)

Now our rendition here captures some of the volatility of prices that escape year-over-year comparisons. Ours is a 6-month moving average rendered at the mid-point. At least you can see why high-frequency inflation hawks get disturbed when you look at this. There is steepness you don’t see. You can imagine one of the hysteria hawks losing sleep over that.

But more interesting and instructive to us is the energy component driving the core and all items. Energy quickly becomes embedded in the all-items headline number, but look at core. Core, as we’ve noted, being a measure that eliminates energy and food – that is commodities – ends up measuring labor input. And here you see one of our – actually following from Warwick University professor Andrew Oswald’s – key observations. Everything in the world is made of energy and labor. If prices are going to remain steady, when the price of one of these components goes up, the other must go down. Energy up, returns to labor down. Looking closely, you can see, even the past ten years – Oh, expand the first chart by clicking on it – that just such a relationship is shown. Energy prices up, all items up, core down. If we lagged it right, you could see it even more clearly.

Now we don’t expect a recovery in labor – core – this time, because we are in a deflationary cycle. When energy prices go down this time, as always led and defined by oil, or as they fluctuate lower over time as you see in our forecast, labor prices will not go up. The deflationary cycle.

Where is the deflation?

It is in asset prices. House prices, financial asset prices, investment goods, capital goods, whatever you want to call it, that’s where the deflation is. We divide them between financial assets and investment goods. Where is my forecast for the index of those? There is no index for asset price deflation. Maybe the stock market. House price indicators. But the rest is locked behind obtuseness. Ask the owner of a downtown office tower how it’s going for the price of his investment good. He won’t say it’s inflating, and he’ll likely say the next owner will be the bank.

This deflation is critical. It kills construction. It stops the investment sector that is the engine of growth. Getting some life back in investments is the only way out of the continuing Depression. As we’ve said, though, there is no life in private investments and these investments will have to be made in public goods.

And as we said, this asset price deflation – or the inflation in previous decades to asset prices – is invisible to the inflation hawks and the Great Moderators. House price inflation was running at ten and twenty percent when Alan Greenspan had his interest rates locked in at one percent. What would have happened had he simply incorporated that inflation number into the CPI. Likely he wouldn’t have been so concerned then about deflation. Might have even raised rates enough to forestall the great financial crisis. Well, no, probably not. Greenspan was in the business of engineering whatever economic activity he could find.

But wait, you say, there has been inflation.

No. There has been commodity speculation. Not investment. Goods are not investments, they are the products of investments. Playing computer games to milk the futures or options markets may make money for the trading house, but it may come up craps, too. Has anybody else noticed the bunny hops in the commodities indexes since the peak of the most recent bubble?

I’ll put that up online.

Tracks of the carnivore in the snow, I say.

This commodity bubble was the trigger for the most recent downturn. We correctly cited that in January, and even back in November 2010. The trigger because it sucks demand out of the economy in a sharp way. In this case, like punching an old man, because the economy is sick and frail. It has grown sick and frail from decades of supply side nonsense and public goods atrophy. Will it blow up? This commodities bubble.

Here From L.Randall Wray

Now, to be sure, the whole thing is going to blow up, in what Frank Veneroso calls a commodities nuclear winter. As prices rise, consumption of the commodities falls (as we are already observing) both through substitution and through conservation. At the same time, additional supplies come on line. Real world suppliers feel the imperative to slash prices to have some actual real world sales. They cannot forever live in never-never land with rising prices and collapsing sales.

There are many shoes that will drop, bringing back the Global Financial Crisis with a vengeance. Commodities crash, default by a Euro periphery nation, failure of a Euro bank, or the closure of Bank of America or Citi. All of these are likely events, less than one standard deviation from the mean; probably all of them will happen within the next year.

No matter what the triggering event is, that commodities nuclear winter will happen.
Nuclear winter. So why is our forecast, even as low as it is, not lower? Because it’s lower than anybody else’s already. Not that watching forecasters is a good idea, but we have leverage on the downside. We have core inflation below zero for an extended period. We have headline dipping below. We have energy prices fluctuating widely – notice they are marked to the right axis, which is basically three times the scale of the left axis where everything else is graphed, and they are still the biggest waves on the screen.

Secondly, it is asset price deflation and unemployment that will reflect the road down, the bottom sloped downward. Commodity prices coming down will put people out of business, perhaps, but there will be an increase in disposable incomes reciprocal to that of the decrease on the way up. Maybe we’ll come up with an asset price index some night.


Now, before we let you go today, we want to bring your attention to a transition we are making from one platform to another. For the near future, you can find us at both and The latter reflects our attempt to get more exposure, capitalizing on being right for the past four years. Relatively right, I suppose. The demand side perspective needs to get into the thought train of more people and find its way into policy.

You can help us by re-upping your review on iTunes. Thank you very much for all those nice words over the past years. We see that some of the things you most liked we’ve gotten away from. But time is limited. We learn a lot from it every time we sit down.

You can also follow us on Twitter, for whatever good that will do. I’ll try to get that straightened out. Link to the posts. Get the Email version. Give us your feedback in the comments or at the address Making money is low on the priority list here. Any ads you see are not endorsed by us. We will probably opt out of the ads soon, but since we can’t see them from our terminal, they don’t really bother us.

We were inspired to go more mainstream, to take advantage of accuracy, just last month. It was the first week in August when we saw in the sky the great turning of economists and pundits, like a flock of birds turning in one motion. Previously the recovery, now the no recovery. It was a beautiful thing.

Here on the ground we, like many of you, saw there has been no recovery. The current non-policy of genuflecting to the powerful hasn’t worked, it won’t work, it can’t work. For anybody.

Ah well, at least they’re going in the right direction now. Too bad they’re still so far above the real world. You know, it’s not brilliance that makes the demand side work when all that hypothetical and market fundamentalism doesn’t. Look at what we’ve got today. When people trot out in their two thousand dollar suits and talk about how important it is to have investor confidence, and that’s bought on the backs of austerity and suffering. When bailing out governments is important only when they can’t pay their bankers. When the Washington Consensus, a program with no successes, is the order of the day. That’s the “confidence” that they are in charge of governments. It seems to me.

One Comment
  1. David Lazarus permalink

    Over the last thirty years asset prices have risen enormously. Far more than for most consumer goods. Some goods have fallen in price over that period. Televisions may be the same price as they were many years ago but they are of a higher quality than even last year. My one criticism of inflation is that it barely represents peoples actual inflation rate. The US definition ignores energy and food. These two segments are the most volatile but they have also make up a large proportion of low income expenditure. Rents or mortgages also make up a large proportion of expenditure and so are clearly under-represented in inflation accounting. A much fairer way for people to see if they are managing to maintain a real increase is for inflation figures to be published for different income bands.

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