The Fed Criticises Bloggers?

Over the last couple of days, in reviewing the news, I have noted that there is an increasing sense of panic and chaos in the world economy. Today, it seemed particularly bad. I typically look at the Telegraph, the Times, the New York Times, the Guardian, and Reddit as a daily routine, and occasionally the Economist. Today, I was confronted with the following economics headlines in the Telegraph (selected examples):

• FTSE 100 Joins in Global Market Tumble
• Warnings of Double Dip Recession Flash Brightly Across the World
• Bank of England Starts to Dust off its Inflation Fighting Credentials
• Roubini: Greece Needs Orderly Debt Restructuring to Avoid Default

Perhaps most shocking was a headline for a commentary by Ambrose Evans-Pritchard titled 'Time to Shut Down the Federal Reserve?' The content of the commentary was not as radical as it appears, and is a response to a rather idiotic paper by Kartik Athreya of the Richmond Federal Reserve, in which he advises that people should not take economics blogs seriously, as the writers do not have a PhD in economics from a decent school. Ambrose Evans-Pritchard, quite reasonably, points out that the experts played a major hand in the development of the economic crisis. Zero Hedge offers an even more scathing reply to the paper, saying:

Alas, all Kartik achieves is to convince the general public that feeding Fed "economists" alcohol after midnight and letting them directly upload their resultant gibberish to the Fed's broad RSS feed the second they think they have a coherent thought , is generally a disastrous idea. In his piece, which has no other intention than to discredit and outright malign bloggers such as Matt Yglesias, John Stossel, Robert Samuelson, and Robert Reich, Athreya says: "In what follows I will argue that it is exceedingly unlikely that these authors have anything interesting to say about economic policy. This sounds mean-spirited, but it’s not meant to be, and I’ll explain why." Instead in what follows, the Fed presents 4 pages of thoughts so meandering, that the author's blood alcohol level must have certainly been well above the legal norm for the duration of the writing of this ad hominem pamphlet.

I am focusing on this paper by Athreya, as it contrasts nicely with the headlines. The Masters of the Universe, sitting in their ivory towers are clearly not in control. Instead, they pull their levers, enact their policy, and it all comes to nothing but more chaos. They propped up the financial system, supporting their selected 'too big to fail' banks, they printed money and poured it into the markets via their favoured financial institutions, and they aimed to drop interest rates to the floor. Despite this, we still see a world economy racked with volatility and close to panic.

That they had a role in the blowing of the bubbles that took a crisis and brought it to the point of disaster appears to be forgotten by people like Athreya. Their arrogance is quite astounding.

What we are now witnessing is that it is not possible for the Masters of the Universe to eternally prop up a system that is structurally flawed. They can continue to pour money into the system, continue to prop up bankrupt financial institutions, but there is a limit to how long they can bury the underlying structural flaws. When money is invested unwisely, someone, somewhere is going to have to pay. It is only a question of 'who' and 'when'?

This is the problem. If you invest in a piece of commercial real estate at an inflated value of $1 million, and the value falls to $500,000, then somebody must accept the loss. For example, if it is a half empty shopping mall, it is not producing the expected return, and the valuation reflects this underlying reality. There is not enough demand for retail space out there. The capital that has been invested in the shopping mall has been misdirected. Workers have input their labour, materials and energy have been consumed, and there it is; a half empty shopping mall built with borrowed money and no prospect of returning that borrowed money. Somebody, in the end, is going to lose their money.

The only way that the shopping mall will recover is if consumers go on another debt fuelled spending binge. If they were to do so, it would only be a matter of time before the debts, wherever they originate, will finally become due, and the problems will return. If consumers are spending 110% of their income, there must come a time when they can no longer spend. If a government is spending 110% of its income, there must come a time when it can no longer spend. We have seen this happen, so why will it be different this time?

If we think of our half empty shopping mall, it should never have been built. The actual demand for shopping malls is, in reality, aligned with actual income, not income + borrowing. Whilst it is possible to build shopping malls based upon income + borrowing, the long term viability of the shopping malls finally comes down to income without borrowing. If the shopping malls are built upon an assumption that income + borrowing is an eternal state of affairs, at some point the investors must lose money. Too many shopping malls will be built, as they are servicing both present income and future income, at the cost of less income in the future. They are building capacity based upon an unsustainable structure.

The unsustainability must finally lead to a point in time where the shopping mall lies half empty. At that point in time, whoever invested their money in the shopping mall will face a loss. Whether a bank, or an individual investor, they are faced with holding an asset, one which has taken labour, energy and materials to build, and which can not return the money that it took to build. How is the money going to be paid back? Who takes the loss?

The essence of the actions of the central banks has been to enact policy to stop anyone taking the loss. However, it does not matter how much they try, there will still, in the end, be far too many shopping malls in relation to the actual income of consumers. What the central banks can not do is the only real solution, which is to jump back in time, and stop the building of the shopping mall or the borrowing of consumers that was the driver of the investment in the shopping mall in the first place. So you come to a point in time where the shopping mall is there as a physical reality, but the demand for the services of the mall are not there.

And what of all of the people who were employed in the shopping mall, or employed in services that supported the shopping malls' operations? The shop assistants and managers, the shop fitters, the security companies, the importers, and so forth. All of these jobs will disappear, with each new unemployed person's training and skills rendered useless (or at least less useful). They must retrain, find new employment in a sector that does not have over-capacity. However, they are not alone, as all over the economy, other sectors built upon the income + borrowing paradigm are in the same position. So it is that the consumer demand falls as unemployment rises, leading to even more contraction of the demand for shopping malls.

How is it possible for the Masters of the Universe to turn back this tide? In their arrogance, they actually believe that they can do so. Pulling this policy lever, or that policy lever, they seek to change the world such that the economy is not structured around actual income and the ability to service past borrowing. They deny that the shopping mall was built upon an unsustainable structure, and try to hide the reality that it represented excess capacity.

Returning to the PhD economists of the central banks, the Masters of the Universe, they have their mountains of theory, they have their magic formulae, they have their policy levers, they have their belief that they can control the system - but - can they really make a world in which nobody loses when an economy has been subjected to structural failures, where investments were directed into sectors that were intrinsically unsustainable?

As each day goes by, it becomes ever more apparent that the Masters of the Universe are, in reality, delusional and impotent. At best, they can delay restructuring. However, in doing so, they will just continue with the investment into unsustainable sectors of the economy, and contribute to further structural flaws in the economy. The more they seek to turn back the tide, the greater the ongoing mis-allocation of resource. And they have the arrogance to criticise those of us who do not have their approved qualifications?

Note: I use shopping malls as my example as they are an easy target. However, this is just a convenience, and does not reflect the extent of the structural problems. There are a multitude of sectors facing the same problems, with each sector with overcapacity having a plethora of downstream overcapacity.