The FED is Trapped

The long anticipated 17th September deadline came. A lot of people thought that this would be the most important date of the year. The FED suggested that on this day they might finally start raising rates from its 0-0.25% range, by 25 basis points. And unfortunately, many people still take this committee of central planners seriously. They didn’t raise it, in case you wonder. And I doubt that they will be able to raise it in the future.

The reality is that the FED is trapped. The Keynesian claim that it is possible to print an economy to prosperity simply is not true – in other words it is a lie. This lie however is so sweet that many people just really want to believe it. But the difference between reality and the Keynesian model is slowly getting so absurd that even the biggest dreamer cannot ignore it anymore. And so this Thursday was probably a big step towards waking people up.

The fact is that the US government has to cook the books to even make it look like there is a mild recovery going on. The measure of inflation is constantly redefined, to make it look lower than it is. This is done for example by so called Hedonic Adjustments. If a product in the basket of goods that is supposed to measure inflation is getting more expensive, it is simply replaced by another that has not gone up in price, and that the government thinks is equally good. So if for example beef is in the basket and goes up in price, but chicken is not in the basket and does not go up, then beef is replaced by chicken in the basket. The idea is that consumers can then substitute chicken for beef and therefore do not experience inflation. So you better like chicken! A cheeky trick to get a lower inflation rate.  That is just one of them.

The unemployment rate is another important statistic that is manipulated. If someone hasn’t found work in one year he is simply kicked out of the statistic, as if he is no longer looking. That way the US now has an official unemployment rate of 5.1%. This, by historic standards, is a really low rate that suggests that almost everyone who wants a job will find one. A good statistic to show how absurd this number is, is the labor participation rate, that means the rate of Americans in the employment market. That rate is at an almost historic low of 62.6%. How does that go together? The answer is that 5.1% unemployment is a fantasy.

Remarkable is that despite all the manipulation going on, the official growth of the US economy is only about 2% per year. That is of course measured in GDP, which is a completely useless unit of measurement in itself. GDP does not measure the productivity of the economy. All it measures is the amount of money that is circulating. That means that if for example the government spends money, even borrowed money, it will show up as GDP growth, independent of how productively the money is spent. The government could employ people to dig ditches and others to fill them up again. The productivity of this work would obviously be negative, but GDP would still go up. GDP also goes up when unproductive asset prices like house prices go up. Amazingly, even though GDP can be manipulated, all the interventions by the government have not managed to get this statistic significantly up.

The FED is trapped. The interest rates in the US have been at 0% for over 80 month. In addition to that the FED has pumped over 3 trillion Dollars of printed money into the economy. And all that has done is to create official growth number of about two percent. The only effect it really had is the inflation of huge bubbles in bonds and equities. The reason for that is that the economy is simply at peak debt. Even at these low interest rates, people and companies cannot borrow more money, because they already have too much debt. The only people who can still borrow money are the financial sector who really gets this money for free and of course the government. Since they cannot kick start the economy again, the official line has been that as long as the stock market is OK, the rest of the economy cannot be too bad.

The trouble is that these bubbles are dependent on cheap money. In order to keep them inflated not only do interested rates have to stay as low as possible, they will soon have to start a new round of money printing. That is a problem, because in the long run, printing money will undermine the trust in the US Dollar. So far that has not happened, because the FED could make everyone believe that it has an exit strategy. Once the US economy is growing, it will hike rates again and buy back all the printed money.

But as I explained above, the US economy is very weak and based on debt. Therefore, if debt gets more expensive the rest of what looks like a productive economy will simply implode. If however they do not hike rates, then more and more people will realise that the exit strategy is not real. Therefore it will undermine the confidence in the Dollar. That way the US economy will also implode. So no matter what they do, it looks like that keynesianism has finally checkmate itself. With this month FED decision to rest rates at 0%, more and more people will realise that the economy is worse than it seems and that the FED is not really in control of the markets.

My guess is that they will not hike rates voluntarily. Eventually of course the market will force them to. There is a small possibility that they will raise rates by 25 basis point in the next few month, but even that is unlikely. The reason is that if they do raise rates, the economy will implode and they will immediately have to reverse the rise. That will make it look like they do not know what they are doing and undermine their credibility. And they cannot really raise rates without a really strong economy, because the US government is highly indebted too. That is the difference to 1981, when then FED chairman Paul Volcker raised rates to 20%. At that time the US government did not have a debt problem. Now they have one and if the economy implodes, tax revenues will go down and dept/GDP numbers will rise, making the debt situation of the government worse. If simultaneously interest rates go up, the government will quickly have to declare bankruptcy. And since the government has more guns than anyone else, they will get the policy that is best for them, that is low interest rates and lots of money printing. So hold on to your hats, there is an inflationary storm coming.

IEA Occasional Lecture: Hayek v. Keynes

The IEA announcement explains:

The great Austrian economist Hayek was the principal defender of the classical policies of Adam Smith and Keynes‘s chief antagonist. The classical model of Adam Smith, his “system of natural liberty,” favoured saving, balanced budgets, sound money (gold standard), free trade and laissez faire. Keynes’s “new” economics sought to turn the classical model upside down during economic downturns such as the Great Depression, in favour of consumption, deficit spending, easy money (paper money), protectionism and big government/welfare state. Both models have fought numerous wars since World War II, each winning battles —and both are in contention to fight for another day.  After each crisis, Keynes makes a comeback. During times of prosperity, Hayek and Smith’s model recovers. Keynesians and policy officials could learn from Hayek: Inflation is a tiger by the tail, and creates dangerous imbalances and asset bubbles in the economy.

Speaker, professor and author, Mark Skousen will delievr a talk asking Who is on Top? at the IEA on 30 May 2012 at 6.30pm.

The IEA are at 2 Lord North Street, London, SW1.

Hayek edges Keynes to victory

Last night’s Hayek vs Keynes debate was a pretty impressive affair. I arrived at the Old Building 15 minutes before kick off and ended up being the last person permitted into the East Building to watch on video link. The long queue of disappointed people behind me had to find alternative entertainment for the evening. It became abundantly clear that this high turnout was achieved with no small contribution from the Adam Smith Institute.

To warm us up we had the latest video from Econstories, which features a senate debate and boxing match analogy which Hayek wins with a knock out blow; yet Keynes is declared winner regardless. It seemed most of us in the video link room had seen this before and thoroughly enjoyed it but a quiet pause at the end of the video was punctured by a passionate stony faced man behind me yelling “pathetic nonsense!” as if the American producers would hear him.

There is nothing like an angry heckle to spoil the mood. People kept their heads down in case a real boxing match kicked off there and then. Obviously, passions in the Keynesian camp also ran high. The young economics geeks could be relied upon to create a parallel dimension on Twitter. In this universe the heckler was openly ridiculed, tweets kept coming, and the sense of anticipation was palpable. There seemed to be plenty to talk about despite nothing new occurring on stage.

The event itself opened with the moderator leading a straw poll. He asked the audience to make some noise and shout “Yo Keynes” and “Yo Hayek”. Very intellectual. Hayek supporters, asked to shout second, were well prepared to add volume to the argument.

Lord Sidelsky offered up a mix of theory, ad hominem and humour and quickly fell foul of Godwin’s Law as he attempted to attach Hayek to Hitler. Jamie Whyte was unexpectedly dry and excessively relaxed. Perhaps he felt that an effort to appear casual would cure his nerves, who knows, but his accusation that Keynesianism was purely an irrational faith in state-action touched a nerve. I found my self willing him to sit up straight and deliver his words with more power and deliver stronger blows.

Selgin also sat back, but was clearly excited to be there, fidgeting, shifting and waving his graphs for the audience. As a result he seemed to dominate the Hayek side of the argument batting away Keynesian arguments with a series of strong sound-bite rebuttals.

Sidelsky attempted to counter with an interesting dentist analogy. Apparently we go to a dentist seeking competent and humble action, and not to be told our teeth will fall out on their own. This was readily undermined by Selgin’s analogy to a hangover which has no easy cure save mature abstinence and foresight. Of course, Sidelsky misses the fact that if my teeth are going to fall out then I may decide, quiet sensibly, not to waste money I don’t have on dentists. Altogether unpersuasive.

Towards the end, debate centred around the policy prescriptions each philosopher would apply to the present circumstances. Selgin’s gave an erudite defence of inaction in case the actions taken caused malinvestments which became the cause of the next meltdown. Here Keynes won out, it seems that the desire to do something  overcomes even the urge to avoid doing harm.

Working with libertarians has introduced an unavoidable Hayekian bias in me. Leonard Peikoff’s endorsement of Ludwig von Mises helps too, but I was determined to listen closely to the Keynesian view. I did my best, and am committed to reviewing the audio as well, but what I heard from the left lacked the conceptual coherence of the Hayekian argument. It did not present cause and effect relationships between all the known features of the business cycle and Hayek’s explanation does. In addition the theory rests on concepts of how individuals make decisions that are readily verifiable against your own experiences. For me, these epistemological problems totally undermine the Keynesian position.

I saw that the Keynesians in the audience had got themselves worked up to make a noise once more for their hero, but justice was done when the more numerous Hayekians shouted them down once again.