In an article entitled “U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff“, Bloomberg states that leading economists Gregory Mankiw and Kenneth Rogoff are advocating significantly higher inflation to reduce real debt levels. This is patently absurd, because is bails out irresponsible borrowers at the expense of responsible savers, and threatens long-term economic performance by undermining confidence in the dollar and the Federal Reserve. Moreover, intentionally inflating away debt would constitute a massive, discriminatory, and non-transparent wealth transfer, so it runs counter to ethics and basic constitutional principles.
Julius, I’d be curious to hear if you disagree, but I believe that a central bank should have only one role: to hold steady the value of fiat currency. The government may elect to engage in popping bubbles and cushioning downturns.
Whether deficit spending and expansionary monetary policy become inflationary depends in part on whether they lead to credit expansion. Although this appears to be happening in mortgage lending, that probably won’t be inflationary as long as foreclosures and excess inventory continue to put downward pressure on prices. So how about lending to businesses? Krugman predicts that the administration’s attempt to “muddle through the financial crisis” will leave the banks weak and unable or unwilling to expand credit. This BusinessWeek article suggests that the matters may be even worse: under pressure to strengthen their balance sheets, banks are aggressively contracting credit:
beginning in March, according to documents obtained by BusinessWeek, JPMorgan Chase suspended credit lines for a large number of business owners. According to someone familiar with the matter, the move affected thousands of businesses. They had been clients of Washington Mutual before Chase bought the ailing bank in September 2008. …
suspending lines of credit is certainly an efficient way to reduce the risk on a bank’s balance sheet. According to officials at the Office of the Comptroller of the Currency, bank reserves for bad loans are based on the total exposure to a customer. So if a bank has a $100,000 line of credit with a small firm and only $20,000 is drawn down, the total exposure is still $100,000, and the bank usually will reserve for loan losses based on that amount. But if they convert the $20,000 outstanding to a term loan and cancel the line of credit, or if they simply cut the line to $20,000, the reserves would be based on that $20,000 figure.
Interest rates don’t matter much if you can’t borrow.
Chinese statistics are said to be generally unreliable, but presumably sales results from General Motors can be trusted–so it’s interesting that GM reported record sales in China for the month of April, up 50% year-on-year. This provides additional support for the view that China’s massive stimulus measures and expansionary monetary policy have succeeded in getting the party started again. Michael Pettis sees a risk that the party could get out of control. I’m skeptical that the government will risk taking away the punchbowl, for fear of provoking a riot. That could mean drunken revelry on a massive scale.
A pair of articles in today’s New York Times by Paul Krugman and Allan Meltzer nicely capture our awkward predicament. At the moment, deflationary pressures appear to be dominant as wages fall, credit conditions tighten, and consumers throttle back. Going forward, the Fed’s extremely expansionary policies seem likely to lead to rapid inflation. Japan’s example suggests that inflation may not be inevitable, but the alternative may not be so great either.
Simon Johnson, former chief economist of the IMF, writes that the US has developed a serious case of financial oligarchy, a disease more often associated with crony capitalism in developing nations. Unfortunately, he seems to be right. The Wall Street Journal has a lengthy article today about the ties between the New York Federal Reserve and Goldman Sachs. The New York Times describes the clubby relationship between former NY Fed president Geithner, now Treasury Secretary, and big Wall Street banks. We have a hedge fund millionaire chairing the Council of Economic Advisors. With oligarchs and their allies installed in key positions of the government and the Federal Reserve, the reluctance of the administration to nationalize the banks or get serious about regulating speculative finance is depressingly easy to understand. As is the billions of taxpayer dollars funneled to Goldman Sachs via AIG, contributing to impressive returns for Goldman shareholders. Our prognosis doesn’t look good.
Whence Julius and I critique–and sometimes lob tomatoes at–global economic theatre. We hope you’ll enjoy listening in. In the words of our dear friends Statler and Waldorf:
–This show is awful!
–Terrible!
–Disgusting!
–See you next week?
–Of course.
Just watch out for the tomatoes.