Arthur Laffer: Get Ready for Inflation and Higher Interest Rates

If you haven’t read economist Arthur Laffer’s Op Ed in today’s Wall Street Journal you should. Mr. Laffer explains how the Federal Reserves unprecedented expansion of the money supply could lead to rising inflation and interest rates that would make the ’70s look benign:

Rahm Emanuel was only giving voice to widespread political wisdom when he said that a crisis should never be “wasted.” Crises enable vastly accelerated political agendas and initiatives scarcely conceivable under calmer circumstances. So it goes now.

Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That’s more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers’ expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

About eight months ago, starting in early September 2008, the Bernanke Fed did an abrupt about-face and radically increased the monetary base — which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash — by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.

The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base — which prior to the expansion had comprised 95% of the monetary base — has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!

I really don’t have anything to add… Read the whole thing and then start asking your elected representatives some though questions about government spending, taxes and the economy.

Related

• 45% Say Cancel Rest of Stimulus Spending – Rasmussen Reports

Bernanke’s Deficit Warning

There’s been a fair bit of buzz about Federal Reserve Chairman Ben Bernanke’s remarks about the need for deficit reduction during his testimony before Congress yesterday.

Many commentators are interpreting Chairman Bernanke’s as bad news for Obamanomics and are arguing that deficit fears will force him to scale back his spending agenda. I disagree.

I suspect Pres. Obama and the Democrats in Congress will use Bernanke’s warning to push for broad tax increases to help reduce the deficit and fund his agenda.

James Pethokoukis explains why we should be worried:

WASHINGTON, June 4 (Reuters) – Sorry, Larry Summers. It’s looking more and more likely that you’re going to be stuck in the West Wing for the duration.

See, if your boss fails to reappoint Ben Bernanke as Federal Reserve chairman come January, it would be a public betrayal worthy of the television reality show “Survivor.” For President Obama has no greater ally: Bernanke is truly the gift that keeps on giving.

The latest evidence came on Wednesday during Bernanke’s testimony before the House Budget Committee. The Fed chairman offered a stern warning about America’s huge budget deficits.

“Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance,” Bernanke said.

Tough, but hardly atypical Fedspeak.

Then Bernanke went a step further. He gave significant credence to the view that the recent rise in long-term Treasury yields and mortgage rates was caused by deficit jitters: “These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings.”

Bingo! We have Fed confirmation: those inflation-hating “bond vigilantes” have time warped to 2009 from 1994 and are hot on the hunt for countries that can’t manage their finances.

Now when talk about the return of the bond vigilantes got louder last week, some were quick to declare it bad news for Obamanomics.

Rising rates, the theory goes, could force the White House to trim its future spending plans and return more quickly to a sustainable fiscal path. So long, universal healthcare. Bye-bye, green investments. And Bernanke playing deficit hawk only adds to that momentum, right?

Not really. Chatter about budget deficits and fiscal responsibility is exactly what Team Obama needs right now.

Here’s why: If you buy the theory of bond vigilantism — that credit markets will force interest rates higher in reaction to unsustainable national budget deficits — then you also have believe the White House needs to raise taxes sharply to pay for all its spending programs or risk a bond revolt.

Indeed, plenty of White House staffers, particularly if they worked for Bill Clinton, probably do believe in the theory. It was Clinton, after all, who chucked his investment agenda in favor of a “bond market strategy” to boost growth by persuading credit markets that the administration would balance the books. Read the rest…

Regardless of how you choose to interpret Chairman Bernanke’s remarks the bottom line is the same: Pres. Obama can not pay for his agenda without finding new sources of revenue. He’s going to have to tax rates across a broad swath of Americans, and not just the top 5% as he promised during the campaign. Bernanke’s warning gives him the opening to do just that.

Related

• Our High-Tax, Low-Growth Future – Francis Cianfrocca,  Contentions

Were Healthy Banks Forced Forced to Surrender Ownership Stakes to Government?

Were Healthy Banks Forced Forced to Surrender Ownership Stakes to Government? It’s question that needs to be answered… From reading this CNSNews.com piece it would seem at least a few “healthy” banks were forced into surrendering ownership stakes to the government:

Last October, then-Treasury Secretary Henry Paulson ordered nine banks that the Treasury Department described as “healthy” financial institutions to surrender ownership interests to the government or else face regulatory action that would force them to surrender ownership interests to the government, according to an internal Treasury Department document.

Paulson’s extraordinary threat culminated in one of the most sweeping government intrusions into the free-enterprise system in the history of the United States.

Judicial Watch, a nonpartisan watchdog organization, used the Freedom of Information Act to obtain a copy of the internal Treasury Department “talking points” that were prepared for Paulson to use at his Oct. 13, 2008 meeting with the chief executive officers (CEOs) of the nine banks.

At the meeting–to which the bankers were called at short notice–Paulson made a conspicuous display of potential government regulatory power.

Paulson was flanked by Federal Reserve Chairman Ben Bernanke; current Treasury Secretary Timothy Geithner (who was then president of the Federal Reserve Bank of New York); Federal Deposit Insurance Corporation (FDIC) Chairman Sheila Bair and Comptroller of the Currency John C. Dugan.

While none of these regulators have responded to inquiries by CNSNews.com, the talking points mention each by first name.

Putting aside for the problems associated with the Federal Government bailing out failing private enterprises… Government officials should not under any circumstances be forcing healthy institutions to surrender ownership stakes to the government. It wreaks of socialism!

TARP Price Tag Could Reach $2.9 Trillion?

CNSNews has a rather frightening report on the Special Inspector General for the Troubled Asset Relief Program’s report to congress.

In short the report says that although Congress limited the Treasury Dept. to spending only $700 billion on TARP  the program’s partnerships with the Federal Reserve and the Federal Deposit Insurance Corporation could bring the total cost 2.9 trillion:

(CNSNews.com) – For many Americans, the $700-billion financial bailout was a tough pill to swallow, but the cost to taxpayers could reach $2.9 trillion – nearly on par with the entire federal budget – according to the watchdog agency charged with oversight of the Troubled Assets Relief Program (TARP).

Although the Treasury Department is only authorized to spend the $700 billion approved last year by Congress and signed by the president, the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) will invest up to $1 trillion each in partnering with the Treasury Department’s TARP.

So the “total projected funding” for TARP is estimated to be between $2.47 trillion and $2.97 trillion, according to the TARP special inspector general’s report released on April 21. That’s not so much less than the Obama administration’s proposed federal budget for fiscal year 2010 of $3.6 trillion.

Related

• TARP: The Looming Debacle – John Hinderaker, Power Line

Holy Crap: $12.8 Trillion Spent, Lent or Committed???

From Bloomberg News:

March 31 (Bloomberg) — The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, to stem the longest recession since the 1930s.

New pledges from the Fed, the Treasury Department and the Federal Deposit Insurance Corp. include $1 trillion for the Public-Private Investment Program, designed to help investors buy distressed loans and other assets from U.S. banks. The money works out to $42,105 for every man, woman and child in the U.S. and 14 times the $899.8 billion of currency in circulation. The nation’s gross domestic product was $14.2 trillion in 2008.

I don’t know what’s more frightening, that our government and the Federal Reserve have spent, lent or committed $12.8 trillion or that they want to spend more?

Here We Go Again: Feds Agree to Citibank Bailout

From the Wall Street Journal:

The federal government agreed Sunday to take unprecedented steps to stabilize Citigroup by moving to guarantee close to $300 billion in troubled assets weighing on the bank’s books.

Treasury has agreed to inject an additional $20 billion in capital into Citigroup under terms of the deal hashed out between the bank, the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. Treasury officials will charge a higher interest rate for the capital injection — 8% for the first few years — than it has charged to dozens of other banks now borrowing money under the government’s the $700 billion rescue package approved by Congress last month.

Here’s my prediction: It’s not going to work…  Sure it’ll make everyone feel good and stocks will rise in the short term but once the euphoria wears off and reality sinks in we’ll be right back where we started.

Michelle Malkin says:

Crap Sandwich 2.0 is morphing again.

We’ve gone from the toxic assets purchase plan to the capital injection plan to the throw-it-all-against-the-wall-and-whatever-the-hell-sticks-sticks non-plan plan.

And there in lies the problem, at least from my perspective… We rushed into this bailout business without really understanding the full scope of the problem and are now groping around in the dark trying to find a way out.