Some People Never Learn

There will always be debate among economists about exactly what caused the credit crisis of last year to explode into such a financial mess. However, there is fairly strong agreement about who and what are the primary suspects. The disagreement arises when determining which suspects played the most important roles. My own analysis puts Barney Frank near the top of the list, because he was one of the leading drivers in the push for Fannie Mae and Freddie Mac to lower lending standards. (You can't have sub-prime loans without lower standards.)

Now our friend Barney is at it again, asking Fannie and Freddie to lower lending standards. He's like some sort of creature from a horror movie; just when you think he's gone, he pops back up with an ax and a chain saw.

Of course, let's not forget that it was only a month ago when Barney did this -- "asking" the now government-owned General Motors to keep a parts distribution warehouse open in his district. I can't think of a better way to bring a company back to profitability than to have Barney on board.

Daydreaming is Good!

This is the best news I've read in a long time, daydreaming is an important way in which the brain works to solve problems. Further evidence that the human brain is a very complex system that we are only beginning to understand.

What is inflation?

I read this article, "Stocks in the Black on Gusher of Cash" in last Saturday's Wall Street Journal. The thesis posited in the article is that the recent surge in global stock markets is largely due to the money that has been created by the Federal Reserve finding its way into stock markets. This is what I have been saying; that the Federal Reserve is purposely trying to raise prices (i.e. cause inflation) by creating money.

Since I read this article last weekend, I have come across numerous other articles discussing the topic of inflation and Fed policies. Obviously, this is a hot topic right now. It also happens to be an area in which I have a great interest. One of my favorite economist of all time (yes, I have favorite economists, which didn't help me get dates in high school) is Milton Friedman, who is the grandfather of modern monetary and inflation theory. Dr. Friedman defined inflation as:

"Too much money chasing too few goods"

It is this definition that leads directly to the premise that, if the Fed is creating money, then there will be more money. If we keep the amount of goods constant, then, by definition, we will have more money chasing the same amount goods, so prices will go up.

The actual functioning of this process is much more nuanced than my simple explanation, and this is where the confusion starts. What I find fascinating is the number of articles I'm reading which seem to doubt or misinterpret the basic underlying definition of inflation. Here's an example, in which the article discusses the role of excess capacity in the economy. The main idea is that having excess capacity subdues the inflationary affects of printing money, because producers are unable, or unwilling, to raise prices when they are trying to unload inventory.

It is not that this argument does not add value to the discussion, but the problem is that it places the impetus for inflation on the producer's incentive to raise prices. The massive increase in money supply, which is presently occurring, changes the playing field in and of itself, and it is the volume of money that starts the inflationary ball rolling. For me, the question is not whether we will have inflation. The question is, will we be able to stop the ball rolling to far or too fast?

This and That

A few items from around the blogosphere (courtesy of the The Wallet blog at the Wall Street Journal)

This one, from Clusterstock, gives a few explanations as to why stocks have been going up so rapidly over the past few months. I tend to agree with the savings and inflation stories.

A bit of optimism from the Richmond Fed. They are claiming that the recovery has already begun. I like optimism, but we should all remain cautious. There is certainly the possibility of more short-term pain before things get better.

Finally, here is some information on tax credits available for energy efficiency improvements to your home.

Maybe We Won't Have Inflation

This article was brought to my attention by one of our clients. The gist of the article is that all of the money being created by the Federal Reserve will not cause inflation as we have been claiming. The gentleman quoted in the article, Lacy Hunt, makes the argument that all of the debt accumulated in the economy over the past decade will continue to be such an economic drag that money won't move fast enough to generate any inflation. I am skeptical about this analysis, because it relies on historical comparisons to times when the nature of the economy and money itself were radically different than now. Drawing conclusions about the current situation from what happened in 1818 strikes me as not very convincing.

Instead, we have to look at the current nature of our global economy, which is characterized by fast moving money that has no national boundaries, rapid technological change, and billions of new economic participants in countries like India and China. I think these are the reasons that we have not seen much inflation over the past decade. However, the current actions of the Federal Reserve are so dramatic that I think a general rise in price levels is almost inevitable.

Mr. Hunt may very well turn out to be right, but I am not convinced that inflation is not on our doorstep.

How Hard Can It Be?

This is the longest we have gone between blog posts since its debut three months ago. And although we may not add content on a daily basis, we have found that our blog has proven itself to be a valuable, and appreciated, part of our ongoing client communication efforts. I have had many clients tell me that they enjoy reading our blog and find it informative. Thank you for your feedback, and please feel free to suggest topics for future posts.

We will continue to disseminate important information directly to clients through e-mail and phone. However, I can confidently say that our newsletter has been permanently retired. This blog is a far more timely and informal way to communicate the type information that used to go into our newsletter, not to mention all the trees we are saving!

I picked a heck of a week to be tardy in making my blog post. One of the most significant events in recent history occurred as General Motors went into bankruptcy, and the stock market went up! There was a time when America believed that "What’s good for the country is good for General Motors, and vice versa". I guess that turned out to be a true statement. It was good for GM to go into Chapter 11, and that was good for the US economy. Only through the mechanisms available in Chapter 11 could GM possibly return to being a profitable company.

I know that it is really a pseudo-bankruptcy, since Uncle Sam in putting up a lot of cash to make the deal work. The thought of our favorite Uncle running a car business is not that reassuring...

Look at what the benevolent Barney Frank did yesterday. I will make no prediction that GM will succeed in re-inventing itself. My guess is that they will fail, and we the taxpayers will waste a lot of money. That said, at least the Obama administration forced the company into Chapter 11, which is probably the best choice, considering the bad choices available to them.