Wednesday, January 30, 2008

The snare of stimulus

"Excessive savings was Keynes' bugbear; he believed that excessive saving had been Britain and the United States' principal problem in the late 1920s, so that only a demand-side kick could re-stimulate the economy. ... We now know that Keynes' remedy was basically wrong. ... However, even those who believe in Keynes can hardly suppose a Keynesian stimulus to be relevant now. Lack of consumer demand has not been the problem in the US economy since 1995, quite the opposite. ... At this point, the long term need is for a radical upward re-orientation of interest rates, to a level that provides savers with at least a 3% real return over and above the current inflation rate of nominally 4%. ... It would also reduce the excessive US investment in housing and financial services, both of which sectors are in the early stages of a very unpleaseant downsizing of their current bloated and carbuncular state. ... A major rise in interest rates would also have the useful side-effect of preventing a resurgence of inflation. ... Even by the heavily massaged numbers of the Bureau of Labor Statistics, US inflation is above 4% and likely to remain there. ...However, a major rise in interest rates we are not going to get, quite the opposite. Instead the Fed, seeking as ususal since 1995 to provide short-term palliatives to Wall Street at the expense of the long term health of the economy, clearly intends to cut the Federal Funds rate further at its meeting January 30th, probably by 0.50% to 3.75%. ... That will have one effect which may appear unattractive, but which to the short-term thinkers of the Fed is beginning to have a strange allure; it will cause much higher inflation. Not the wimpy 4-5% inflation from which we are currently suffering, but a genuine take-no-prisoners 10-15% inflation. ... House prices got too far ahead of incomes. ... It is a clever solution, first practised (largely accidentally) in Britain in the 1970s. ... However, in 1975 inflation ran at 25% and it remained well into double digits for the next five years. ... It would enrich homeowners and heavy borrowers, and impoverish pensioners, savers and renters, thus intensifying the Latin Americanization of the US economy", Martin Hutchinson (MH) at, 21 January 2008.

Stephen Cecchetti, please read this. I read John Maynard Keynes' (JMK) General Theory, 1936, and didn't realize what JMK was talking about until page 336 of his 365-page magnum opus when I realized JMK had taken old mercantilist fallacies and dressed them up with new terms. I don't believe JMK believed a word he wrote, but decided to give the US and UK governments a rationale to reduce real wages through inflation and money illusion.

I agree with MH and have long thought the Fed's "plan", which even Helicopter Ben does not understand, and will slide into, is to drive US inflation rates to 6-15% for a decade averaging 12%, with measured inflation at 4-6%, averaging 5%. After a decade of this, US prices will be 211% higher, with nominal inflation of 63%, greatly reducing Uncle Sam's real debt burden.

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