Federal Reserve trillion dollar plan - good explanation

[dex]

This is a good article - it explains the new Fed plan.

Hussman Funds - Weekly Market Comment: Fed and Treasury - Putting off Hard Choices with Easy Money (and Probable Chaos) - March 23, 2009

The reason we're not seeing inflation here and now is that despite a near doubling in the monetary base, we've seen a buildup in goods inventories combined with a surge in safe-haven demand for government liabilities. So investors have absorbed the increased supply of government liabilities without a collapse in their marginal utility. This will not persist indefinitely, so unfortunately, any nascent economic recovery in the next couple of years will be against the headwinds of both Alt-A mortgage defaults (coming to your neighborhood in 2010), and inflationary pressures as soon as safe haven demand for Treasuries eases back even moderately.
Milton Friedman was mostly right about inflation – inflation may be a monetary phenomenon, but only because governments ultimately can't help but monetize huge amounts of spending (as the Fed is doing now). He was entirely right about fiscal discipline – “the burden of government is not measured by how much it taxes, but by how much it spends.”

 

[ziggy29]

Here's the thing.

I could create a magical printing press that could crank out fake U.S. currency that's indistinguishable from the real thing. I could print a trillion, two trillion, three trillion or more, and if I tucked that bogus currency in my closet or buried it in my back yard, there would be no added inflation because that cash isn't getting into the economy. The velocity of that money is zero.

But if I spent those triillions and injected it into the economy -- if I gave that money some velocity -- it would be inflationary.

So the way I see it, as long as consumers, businesses and banks hoard cash instead of spending, borrowing or lending it, the money that's being printed to accommodate the Treasury buybacks won't be inflationary. But when these entities decide to start spending or lending, it will be.

 

[Gumby]

So when do we start investing in gold?

 

[MichaelB]

Here's the thing.

I could create a magical printing press that could crank out fake U.S. currency that's indistinguishable from the real thing. I could print a trillion, two trillion, three trillion or more, and if I tucked that bogus currency in my closet or buried it in my back yard, there would be no added inflation because that cash isn't getting into the economy. The velocity of that money is zero.

But if I spent those triillions and injected it into the economy -- if I gave that money some velocity -- it would be inflationary.

So the way I see it, as long as consumers, businesses and banks hoard cash instead of spending, borrowing or lending it, the money that's being printed to accommodate the Treasury buybacks won't be inflationary. But when these entities decide to start spending or lending, it will be.

The Fed can attempt to manage the supply of money over time to limit inflation, but it cannot offset the additional debt being taken on by the federal government. Higher inflation is one outcome, higher taxes and savings rate (to pay down the dept) is another. Either way, we will have less disbosible income - and a lower standard of living. As will our children.

 

[Spanky]

So when do we start investing in gold?

Yesterday?

 

[FUEGO]

So when do we start investing in gold?

A few years ago when it was trading around $300 an ounce. Didn't you get the memo?

 

[youbet]

An interesting read indeed......

I liked this statement:

Treasury inflation protected securities, precious metals shares, and foreign currencies all advanced sharply following the Fed's announcement last week

I had been slowly accumulating TIPS at auction (grabbed some of the 2.125% 10 yr and 2.5% 20 yr TIPS) and some shares of the etf TIP when they were selling in the mid $90's. Thanks to the Fed jumping into this market, real yields on TIPS are down and I would assume will stay down through the April auction. The price of the etf TIP is up.

Wish I had accumulated a little faster before our govt got into the act.......

 

[Gone4Good]

People like Hussman really need to square statements like this . . .

Though I believe that the consequences (via credit default swaps and the like) are overstated of letting bondholders take a haircut,

and . . .

A continued policy of protecting all of these bondholders would eventually require U.S. citizens to be put on the hook for something on the order of $10-14 trillion.

So we're to believe that the financial system can absorb $10-$14 trillion in losses (by his estimate), likely in uncontrollable, cascading failures (my estimate, based on the nature of panicky markets and our collective experience with Lehman) without doing further damage?

His proposal . . .

The U.S. government takes receivership of the financial institution, changes the management, wipes out the stockholders and a chunk of the bondholders claims entirely,

Strange that he doesn't walk through how this would work in the real world. I'll help . . .

It would start with mass panic selling of every marginal financial institution that is thought to be at risk for "receivership". As "confidence sensitive businesses" all of them would go broke pretty quickly. Then we'd move on to mass panic selling of every other financial institution that has, or is thought to have, exposure to anyone at risk for "receivership". In other words . . . mass panic selling of nearly every financial institution. As "confidence sensitive businesses" they'd all go broke too.

Once we're finished wiping out most of the financial players, then we can start the mass panic selling of every other corporation whose liquidity is now questionable (which is almost everyone). Why is liquidity questionable? Well the corporate bond market is shut down because the biggest players (insurance companies and pension funds) have just suffered massive losses on all of their financial holdings (good thing we taught them a lesson by wiping out their bonds, huh?). The commercial paper market is shut down because of the massive CP defaults (see above). This has caused a run on money market funds, which will be inevitable even with government guarantees (which, by the way, puts the taxpayer on the hook for at least part of the losses you thought you were avoiding ). Revolving credit lines shrink dramatically because our big money center banks are now in receivership and won't make good on their lending commitments.

So basically only companies with massive cash hoards are safe (at least for the time being). Everyone else drastically cuts capital and operating expenses to preserve liquidity. Resulting in accelerating downward pressure on the economy and employment. Etc, etc, etc.

This progression is all very clear. What's not clear is how or why the downward spiral ends once it gets started. I looked for the answer in the article, but Hussman didn't say.

 

[Gone4Good]

Hussman's link between government spending and inflation is also flawed. Take a look at his chart. The data stops at 1955 . . .why is that? Certainly CPI and government spending data goes back to at least the turn of the century. So why not include a longer time horizon? The answer is that it completely discredits his argument. From 1930-1945 annual government spending soared 2,818% ($3.3B to $93B) while the inflation index rose just 4.1% (17.1 to 17.8) over 15 years. Then from 1945-1955 annual government spending declined by 26%, but the inflation index rose 50%.

Check for yourself here . . .

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://www.gpoaccess.gov/usbudget/fy09/pdf/hist.pdf

What's worse is that his government spending data is based on nominal dollars (I tied back to the results of his charts to prove this). Nominal spending includes the impact of inflation so they're correlated by defintion. In fact, if you were to hold "real" government spending constant, the 4 year average change in spending depicted in his graph would exactly match the 4 year average change in inflation. So his graph doesn't show that government spending increases inflation, what it shows is that "nominal" spending includes an inflation component . . . duh?

If, instead, you look at "real" government spending, you find that the correlation between average 4-yr changes in spending to 4 yr changes in the inflation index is a paltry .21 with a .05 R2. Nominal spending, meanwhile, correlates .77 with a .59 R2.

So why is Hussman deliberately putting out analysis based on faulty data and conclusions . . . any guesses?

 

[kumquat]

And if TIPS are indexed to CPI and the government determines CPI and........