Tag: Ben Bernanke

The fantasy of infinite growth

A fascinating and powerful message from CASSE.

(Apologies to all you readers – bit under the cosh at the moment in terms of free thinking time – so have lent on this timely update from CASSE for today.)

From CASSE, the Centre for the Advancement of the Steady State Economy

Why Do So Many People Believe in the Fantasy of Infinite Growth on a Finite Planet?

by Rob Dietz

How do you feel about the economy these days? How about the environment? Do you think we’re sitting in a better spot than we were ten, twenty, or thirty years ago? It’s hard to find folks who are satisfied with either economic or environmental conditions. In the first place, the way we run the economy is producing appalling results. We have a mix of financial fiascos, unacceptable unemployment, and a dismal disparity between the haves and the have-nots. And if you’re not soiling yourself (or at least somewhat concerned) about what’s happening on land, sea and air, then you’re not paying much attention to the omnipresent signs of environmental breakdown.

Each day it becomes more apparent that we are on a misguided mission. Pursuit of perpetual economic growth is not a winning proposition for a lasting prosperity. Building a bigger economy can make sense in some circumstances, but always aiming to build a bigger economy means taking an ever-bigger chunk out of the earth’s ecosystems and the life-support services they provide. Why, then, do so many people believe in the fantasy of infinite growth on a finite planet? Is it because we can’t come up with a better idea? Is it because the rich and powerful have trapped the rest of us in their web of conspiracy? Is it because people are hopelessly greedy and materialistic?

At various times and places we might answer these questions affirmatively, but we can more commonly answer, “No, no, and no.” Putting aside conspiracy theories for the moment, there are three honest (but bogus) reasons why we pursue economic growth past the point of effectiveness and reason.

Bogus Reason #1: We think we have to have economic growth to create jobs.

People, and especially politicians, want jobs. We’ve used the blunt tool of economic growth to create jobs for decades, but do we really need economic growth to have good jobs? It’s true that there are typically more job openings in a growing economy, but there are other, less costly ways to make sure jobs are available. Growth, however, gives corporate elites an easy out. They can point to economic growth as the job creator while doing what they want without considering the impacts of their decisions on jobs.

If jobs are really the priority, then we wouldn’t replace people with machinery. And we wouldn’t eliminate service jobs to shift more and more burden onto people to serve themselves. My friend Chris works as a gas station attendant and provides a valuable service pumping gas for customers. He wouldn’t have a job, however, if he lived elsewhere. He happens to live in Oregon where the law says that only professional attendants can pump gas. In most states, gas station attendants have been replaced by customer labor and credit card readers. This sort of substitution has become commonplace in the name of efficiency — policy makers find it easier (or at least they’ve found it easier in the past) to avoid considering jobs explicitly. Just grow the economy and let Chris find a job elsewhere — that’s just the way it goes if his job is eliminated and the customer is forced to pick up the slack.

The truth is that we can have good jobs without producing and consuming evermore stuff. For starters, we can institute policies to make job-sharing an attainable reality. Many people would gladly trade some salary for more time. We can also stop the process of eliminating jobs through outsourcing and machinery-for-people swaps. Of course stopping this process would require a change in corporate incentives…

Bogus Reason #2: Screwy corporate incentives require growth.

Shareholder corporations are severely flawed. In my household, let’s say my overriding goal is to maximize my earnings. What would I do? I would take the highest paying job I could get. I certainly wouldn’t be involved in public policy or a not-for-profit enterprise. I wouldn’t spend much time with my wife or daughter — that would be time away from my career, and it could eat into my earnings (cue the Cat’s in the Cradle). If the goal is so single-focused, the results aren’t surprising. Profit maximization, whether it occurs in my household or in a corporation, produces perverse outcomes.

We know this about shareholder corporations. We know there are better ways to set up productive enterprises that have more worthy goals, but we don’t make the change. The reason is that we are addicted to two things corporations do well. First, we’re addicted to consumer novelty. We’ve gotta have the latest and greatest. People chase after I-phones, I-pods, I-pads, and plenty of other I-wants. Second, we’re addicted to receiving unearned income from investments in stocks or mutual funds. People who can afford it are invested in corporations. Their personal wealth is tied to the ability of corporations to grow. We’ve become accustomed to the idea of passive investment — we put extra money into an account and do absolutely nothing but watch the size of the account get bigger. Are we really entitled to get something for nothing?

Bogus Reason #3: We refuse to pay attention to the downsides of economic growth.

Few people are studying ecology and understanding how economic growth is degrading environmental resources. In fact, a whopping 21% percent of college students are business majors. And as Dr. Seuss noted in his classic book, The Lorax, “Business is business, and business must grow!” While we continue to tempt fate by disrupting and dismantling natural systems that we only partially understand, our attention is locked on the results of reality TV shows, Tiger Woods’s sex life, Jennifer Anniston’s and Justin Bieber’s haircuts, fairytale weddings of figurehead monarchs, and other matters of critical importance.

While we’re failing to pay attention, those who benefit most from growth — the corporate elites — will keep on doing what they do, and they’ll keep on selling it to the rest of us. If we don’t start asking, “why?” real soon, our kids will one day be asking “How did we let this happen?”

Unwinding $1 trillion in Toxic Assets

Ben S. Bernanke, Chairman of the Federal Reserve

Used toxic assets, anyone?

Ben Bernanke, Chairman of the U.S. Federal Reserve, announced that the Fed was likely to begin to sell some of the $1 trillion in mortgages, the so-called “toxic assets,” that it purchased over the last fifteen months to help stave off a total credit market meltdown. Those purchases essentially doubled the U.S. money supply, igniting fears of potential inflation should the underlying real economy recover before the money supply could be drawn back down. See earlier post.

Well, the process of tightening the money supply may be just around the corner. And increases in interest rates and the cost of everything purchased on credit – homes, cars, durable goods, and business capital expenditures – are not far behind. Increases in interest rates dampen economic activity, an unfortunate development given the current lethargic state of the U.S. economy. But it has to be done sometime – we cannot sustain such a huge increase in the money supply without paying an even higher price in terms of inflation and a weak dollar.

It will be interesting to see who buys the toxic assets and how much they will pay. Regardless, the sale will reduce the money supply which, if done in a slow, orderly manner, is a good thing for the economy. Getting the Fed out of the business of buying and selling private market securities will be an even better thing for the U.S. economy. Now more than ever we need a monetary authority that is focused on the best policies for our economy, not those that help Fannie Mae, the White House, or the Treasury Secretary save face.

By Sherry Jarrell

Should you invest in U.S. bonds?

Could the U.S. government default on its bonds?

I’ve been asked many times over the years for advice on investing. “What is the market going to do?” “Should I be invested in stocks or bonds?” And, especially in the last few weeks, “Should I hold U.S. or foreign government bonds?”

A U.S. treasury bill

Those are some good questions!  The answers are not as “good.”  The factors that drive the yields on treasury bills and bonds are complex and, despite Ben Bernanke’s pronouncements to the contrary, less well understood than stock returns, and I don’t have a crystal ball, but I can at least begin to frame an answer to these questions here.  I will come back to expand on this topic over time, as markets, economies, and world events evolve.

The return on both bonds and stocks is measured as the percent change between the market price today, and the cash flows received later.  The cash flows of a bond, namely coupon payments and principal, are specified in a contract; if they are not paid, the issuer is in default, and the bondholder has the right to take them to court.  The cash flows on stock, dividends and capital gains, are residual; they are discretionary, and are paid out only after debt payments and other obligations are paid.  For this reason, bonds are considered to be less risky than stocks, and the nominal yields on bonds are generally lower than those of stocks.   The risk-adjusted returns on stocks and bonds may be the same, but the nominal yields on bonds are typically lower.

There is an important distinction between the nature of the returns on bonds and stocks. With bonds, the future cash flows are known.  Movements in the bond’s yield are determined simultaneously with movements in the bond’s price. Once a bond is issued, only changes in interest rates (yield, risk) drive unexpected changes in its price.  Stock prices, on the other hand, fluctuate as either risk or residual cash flows change.  As a result, changes in a bond’s price, hypothetically at least, are a much cleaner indicator of the market’s expectations of future market rates of interest than a stock’s price.

One problem that distorts the information about expected future interest rates that is revealed by changes in the bond’s price is that bonds are less frequently traded than stocks, so the price data on bonds is less comprehensive and complete. In addition, the reported price data that form the basis of bond yield models often diverge from actual market-clearing prices, so that bond pricing models may not describe actual market behavior. Lastly, there is such a tremendous volume of economic and policy information, some of it conflicting, that is crammed into this one variable, the bond price which, given the coupon and principal, summarizes the market’s referendum on future interest rates.

by Sherry Jarrell

Next time: Sources and types of risk in U.S. and other bond prices.

Why the Fed Raised the Interest Rate

Contractionary Fed policy in a recession?

What does it mean when the Fed raises the interest rate? It helps to first understand how the Fed raises the rate, which may surprise some people.  The Fed does not “set” the interest rate as it might, for example, by declaration or edict or by fixing prices.  No, it targets a higher interest rate by contracting the money supply until that money supply intersects the market demand for money at a higher market-clearing rate of interest.

Ben Bernanke, recently reconfirmed Fed Chairman

How does the Fed reduce the money supply? Typically by conducting open market operations, which is the purchase or sale of government securities by the Fed.  To raise the money supply, it purchases new government securities, paying for them by creating — out of thin air — reserves for the commercial banking system. To reduce the money supply, it sells securities which shrinks the amount of deposits in circulation in the economy. In other words, it reduces the liquidity or amount of credit in the system.  This is equivalent to reducing aggregate demand for the goods and services in the economy. (Yes, you heard right — a reduction in the money supply decreases the aggregate demand for goods and services by businesses and consumers.)

Raising interest rates is a contractionary policy decision.  It is designed to “slow down” the economy, reducing output and employment, and raising the equilibrium prices of goods and services in the economy.  Why would the Fed choose to contract an already anemic economy?  To head off inflation, which has it own set of insidious costs and distortions that significantly hurt the economy.

The Fed has always had to tread a very fine line between increasing the money supply enough in the short run to pump up demand and minimize the depth and length of a recession, but not increasing the money supply so much that the increase in demand outstrips the ability of the economy to produce, which creates inflation in the longer run.   Excessive money growth is what causes inflation.  And over the last two years, the U.S. has witnessed a record-shattering increase in the money supply as policymakers struggled to deal with an unprecedented financial crisis.

I have been saying for months that this behemoth money supply would inevitably lead to significant inflation unless steps were taken to shrink it.  I believe the Fed has now begun to take those steps.

By Sherry Jarrell