Tuesday, June 29, 2010

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.


  1. Good post. I note these words in Ambrose Evans-Pritchard’s article:

    Matters of economic policy should be reserved to a priesthood with the correct post-doctoral credentials, which would of course have excluded David Hume, Adam Smith, and arguably John Maynard Keynes (a mathematics graduate, with a tripos foray in moral sciences) …. Have [the central banks] … all forgotten Keynes’s cautionary words on the “tyranny of the general price level” in the early 1930s? Yes they have …. Have they forgotten Irving Fisher’s “Debt Deflation causes of Great Depressions”? Yes, most of them have. And of course, they completely failed to see the 2007-2009 crisis coming, or to respond to it fast enough when it occurred.


    Quite so.

    Also, you say:

    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.

    Most countries are deleveraging. This means growth isn’t coming from private debt.
    Private debt to GDP ratios are falling. Steve Keen has demonstrated this clearly:


    In the face of deleveraging, government spending is what keeps the economy from suffering brutal debt deflation.

    If unchecked, this destroys productive and profitable sectors, not just private-debt-created shopping malls.
    Orderly writing off and restructuring of debt is needed. For example, a new government-created Homeowners’ Loan Corporation:

    [the FDR] administration created a credit agency for the financially distressed homeowners, Homeowners’ Loan Corporation, which bought mortgages from private holders at prices that reflected realistic or going market values that eased their terms and allowed homeowners to meet their affordable obligations and stay in their homes.


    But to prevent debt deflationary effects on real economic activity, deficit spending is necessary. Debt-free fiat money is the life blood of healthy economy.

  2. There is an excellent paper here on the history of fractional reserve banking dispelling that myth that goldsmiths were fraudulent:


  3. Excellent post. Thanks!

    In my opinion the danger for the UK is that Labour were wounded - but not yet mortally - as can be seen by the relatively high poll ratings.

    The inevitable return to recession (because we're never really left recession in the first place) will be blamed on the coalition and - as was always the plan - the opposition government will claim that had it been in power its policies would have "worked".

    This sows the seeds for a return to power once austerity (reality) starts to bite. I wonder if, in years to come, we'll have wished Labour won in 2010, if only to see what left-wing lunacy does when allowed to run to its economically-bloody conclusion.

    My hope is that the tough decisions being taken now will have an effect before another election is due. But the truth is - they probably are not tough *enough* to work quickly in the short term. And they don't deal with the most fundamental problem at the route of everything - over-regulation and poor regulation of the markets.

  4. "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?"

    Going ok up to that point. Government spending cannot be equated to household spending unless you are a state of the US or a member of the EMU.

    As a matter of accounting what the government spends, is our savings on the other side of the balance sheet.

    Good article on sectoral balances from a slightly less 'government stimulus is everything' perspective here: http://www.interfluidity.com/v2/871.html

  5. That was a great post I must say!

    Economy blog writers may not have "proper" backgrounds, but they have something that other "high degreed" people lost during the years. This thing is called unbiased perspective.

    If you are interested in interesting fact regarding the economy, I suggest to visit the following page:


    I do not want to advertise, but to share another point of view. Have nice day! :)

  6. Good blogg

    Most Phd students are chosen on their ability to regurgitate accepted dogma-Kuhn "The Structure of scientific revolutions"--and their inability to think outside of the box, although admittedly Russell would argue that the "Box" is not really there, and that it is merely fragment of our imagination.

    The intelligent reader will notice straight away that there is a flaw in the last sentence, that there is a huge difference between the "box" of the real world, and the "box" of the adjective construct. Perhaps the difference between them is not so clear to many policy makers?

  7. I've read and re-read Kartik Athreya's paper and to borrow one of your lines Cynicus, I just don't buy it.

    That is I don't buy the hysterical reaction from a number of people who perceive (wrongly in my view)that his observations are critical of them per se.

    Or maybe I'm reading it wrong?

    Perhaps I'm reading it using my 'yeah that makes sense' calmly rational inner voice, rather than joining in with the melee of stone throwers intonation that mouth out loud each word of the article and getting ever more irrationally exuberant.

    The main thrust of his article surely left the reader thinking that Kartik questioned his own ability along with that of his peers despite many years of learning, concluding that at best, they were in a less darkened room than the vast majority of opinioned posters.

    Seems a reasonable conclusion to me, or am I in that comfortable crowd of 1?

    Dave O'Carroll Romford

  8. One of the bigger issues I have with that rant by Athreya is that (s?)he absolutely refuses to go into specifics, and meanwhile still manages to slur one of the most ardent fighters for the rights of 'normal' citizens out there - Elizabeth Warren, without even making clear what his specific issue is. Is it that she's speaking out on policy issues and proposed legislation while TARP overseer, and thus intimately familiar with the utter failure of that policy? Or is it something else?
    This is rhetorically weak, and intellectually dishonest as can be, but apparently the author felt no real desire to try for fairness. As such - given that it is formulated as a blanket condemnation without the author committing to any potentially disprovable examples or assertions - it is a piss-poor attempt at adding one's voice to a discussion.

  9. Interview with Dean Baker:


  10. Many moons ago I used to comment here, since then I have been a semi regular lurker.

    Much water has flowed under the bridge since then. They say even a week is a long time in politics.

    I thought I would try and find one of my old comments from that time, I clicked on the sidebar for 2008 and sifted through some old comments hoping to recognise something of mine, sadly without success.

    Perhaps that's one of the penalties for posting as anonymous, especially if one cannot recall what one said.

    However, I soon came across a comment which I thought could have quite easily have been written by me and hereby reproduce below. Mind you, I’m not claiming it is mine you understand.

    It was a comment made in response to a post by Cynic entitled, ‘Banker Regulation-Banker Beware.’ Friday 26th December 2008.

    Here is the comment.

    Anonymous said...

    “I'm not sure you picked the right target here, banks are way down the food chain of capitalism and thus nothing more than a tool.

    Capitalism (to me) is the ideology of the manifestation of greed in the human soul, it is the working of a philosophy that rewards and maintains the status of the rich, the entrepreneurial and the brightest of the human crop.

    I suppose you could say it's the perfect system for the richest and brightest to legitimately rob the teeming masses and keep them in their place. Having said that, capitalism supplies the goodies we all crave - capitalism is a two edged sword.

    Up to the present day, capitalism has served humans well, but life is evolving rapidly (too rapidly, we can't keep pace) capitalism has, it seems passed its sell by date and is no longer fit for purpose. In other words it is the end of the world as we have known it for generations.

    The movers and shakers of this world have been aware of this situation developing for a long time and that it would soon be with us, lesser mortal haven't a clue about anything, and further more couldn't care less as long as they can charge down the mall for their 70% off.

    We in the West now live in a post industrial world, we don't manufacture much anymore, and what is manufactured can be produced by automation so we don't need the workers anymore - hence daytime television.

    Whether sufficient wealth can be created by cutting each others hair I am not qualified to say. We are now living in uncharted territory, what used to be ain't no more, our civilisation is in crisis, we can't go forward and we can't go back.

    Interesting times.”

    27th. December 2008 1.25 AM.

    I remember posting at that time some comments about mass immigration, Peak Oil and the New World Order and how this economic crisis was/is a deliberate taking down of Western civilisation to converge with the standards of the Third World and the emerging NWO. I would go on to opine that debating nation’s economic policies in isolation of the geopolitical was a waste of time.

    New World Order – aka Cultural Marxism, Political Correctness, Globalism, Progressive Transnationalism.

    I beat a hasty retreat. (LOL)

    However, I was prompted to comment here again because have just read this. (In addition to a shed full of other such information over time.)


    Carry on pulling the levers, carry on pressing the buttons, keep kicking the tyres.

  11. Wonderful "Success" of Austerity in Ireland:

    Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes .... Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession. Joblessness in this country of 4.5 million is above 13 percent ... It now pays a hefty three percentage points more than Germany on its benchmark bonds, in part because investors fear that the austerity program, by retarding growth and so far failing to reduce borrowing, will make it harder for Dublin to pay its bills rather than easier ... the country is facing a new threat: business leaders say thousands of skilled young Irish are now moving out, raising fears of a brain drain.

    In Ireland, a Picture of the High Cost of Austerity.

    So the path to prosperity is... 13% unemployment, 14% contraction in GDP since 2008, higher yields, and a brain drain.

    Despite offically emerging from recession this year due to exports, unemployment rose to 13.4% in June from 13.2% in May. Some “recovery.”

    And an export-led return to growth seems unlikely if there is further EU austerity.

  12. Ireland’s Budget Deficit highest in EU in 2009

    Ireland officially recorded the biggest government deficit in the EU [in 2009]. Revised figures, published today by the EU's statistical agency, Eurostat, show Ireland's deficit for 2009 at 14.3% of Gross Domestic Product - higher than Greece at 13.6% and Britain's 11.5%.


    So the austerity…. the biggest budget deficit in Europe. Its current account is still in deficit. So, despite austerity, Ireland is clearly still “living beyond its means.”
    No doubt the advocates of austerity will complain that the austerity just wasn’t large enough.
    As for the budget deficit, in 2010 it will be even worse:

    Ireland's budget deficit could rise to 24% of GDP (gross domestic product) in 2010 or about €40bn, following a ruling by Eurostat, the statistics office of the European Commission, on the treatment of public spending on the State nationalised Anglo Irish Bank.


    So all that austerity just leads to higher unemployment and increased government spending on welfare and automatic stabilizers.

    As the markets, they have less confidence in Ireland than they do in Spain where austerity has not been so deep:

    [sc. Ireland has a CDS [credit default swap] spread of 226 basis points, compared with 206 points for Spain; not to mention a 10-year bond rate of 5.11 percent, compared with 4.46 percent for Spain.


    We keep hearing the relentless mantra that governments have to “appease” the bonds markets, and yet there’s not one iota of proof that severe austerity will “appease” them at all.

  13. @Lord Keynes

    One of the common themes of this blog is that GDP is a meaningless indicator - over the short term anyway. So all your references to how 'austerity' makes the debt-to-GDP ratio higher is just stating the obvious. We already know!

  14. Reply to Lemming

    One of the common themes of this blog is that GDP is a meaningless indicator

    The view that GDP is a “meaningless” indicator is utterly false. I am surprised you would seriously believe it. My new blog post refutes the idea:


  15. Lord Keynes:

    Just a quick note. Whilst I welcome your comments overall, I think that you may be overdoing the commentary somewhat. I note that one of my readers commented on this on another post. In the case of my reply to your past criticisms, it is quite right that you have a right to reply. However, for other posts, a self-limit might be a better approach.

    If you review the past posts, you will note that the volume of your comments is sometimes comparable to the original post. Also, many of the comments stray away from the specific subject of the post.

    I have to emphasise that your comments are welcome, but some moderation in volume would be better.

    As a general note for all readers, I will be away for about a week, and therefore may not be able to update/post comments as often as usual.

  16. Cynicus, I heartily agree with your belief that GDP is a pointless indicator of the health and wealth of a nation but the truth of the matter is that the vast majority of the financial world and sovereign states hold the opposite belief and as we all know, belief is a very powerful thing (you should see how well behaved the kids are on the run up to christmas ;)

    Unfortunately for LK and others, there is plenty of evidence that your way of thinking is closer to reality. This recent post on Naked Capitalism gives a nice chart of GDP along with GDP+change-in-debt for the Great Depression era and now - I particularly like the 2 orders of magnitudes change in scale on the y-axis between figures 1 and 2 yet we still generally earn just enough to pay the bills. The purpose of growth is what??

  17. "The elite's goal in our estimation is world governance and the elite has created a massive establishment of varied military, economic and sociopolitical tools to reach this goal. Chief among these tools is an economy based on "money from nothing" – fiat money – issued by powerful central banks throughout the Western world. Such fiat money causes booms and then busts that lead inevitably to more centralization of money, power and resources in the hands of the few that control these banks."



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