Make nominal spending the new target? We hope not.

In the January 2 2013 edition of the Financial Times Mr. Scott Summer, economics professor at Bentley University, publishes an article titled Make nominal spending the new target, where he argues for the revolutionary, and increasingly MSM-pushed idea of making Nominal GDP Targeting (NGDPT) the official policy of central banks in most western countries. This policy was already hinted last December at a conference in Toronto by the present governor of the Bank of Canada (BoC), and future governor of the Bank of England (BoE), Mark Carney.

This in an article fraught with ideas that, if implemented, will permanently transform the nature of western economies and pave the way for structurally high inflation, potential hyperinflation, economic misallocation of resources, moral hazard (savers, wage earners and pensioners being punished), and general impoverishment of the population except for the few taking advantage of it thru their access to cheap financing: financial institutions and überwealthy individuals.

Mr. Scott Summer states: “Once a central bank sets an inflation target, they have essentially set a path for aggregate demand. In that case, what possible role can there be for fiscal stimulus? But as the past few years have shown, stimulus advocates and opponents are as vociferous as ever. And despite a widespread perception that most developed economies would benefit from more demand, central bankers seem unwilling or unable to deliver that growth.”

TYR states: This paragraph foreshadows the huge amounts of half-truths and outright lies that conform the article. It sets the stage for the assertion that a central bank’s main role is to foster “demand”, foster growth. This has never been the role assigned to monetary policy, whose main aim is, and should be, to preserve the purchasing value of the currency, that is , to keep inflation low. By positing that central banks should aim at fostering demand, the author conveniently ignores the fact that nominal GDP growth comes at the expense of inflation, that by debasing the currency in order to reach a theoretical NGDP target, no real growth is achieved, only the appearance of it, since that growth is basically inflation. This has been well-known since roman emperors clipped their silver coins. A not so obvious harm that such a policy would cause is a further misallocation of resources in the economy. By artificially fostering some sectors of the economy that depend on cheap financing (finance, housing) thru monetary policy, the same misallocation that was an important cause of the 2008 crisis is being perpetuated.

Mr. Scott Summer states: “Inflation targeting failed in two ways. First, it was a poor indicator of the adequacy of aggregate demand. Second, it is susceptible to “liquidity traps”, a period of near zero interest rates where central banks’ favourite tool – interest rate targeting – is rendered ineffective”.

TYR states: Inflation targeting was never intended to be an indicator of aggregate demand, but a (bad) tool to control inflation, the main aim of the guardians of the currency, central banks. Liquidity traps, a Keynesian and non-scientific term, is not caused by inflation targeting, but by debt overhangs, resulting in crisis, like the one in 2008, originated in  previous monetary laxity, precisely what the author recommends as future policy.

Mr. Scott Summer states: “This problem occurs because when the economy is very weak, even a 2 per cent inflation target might not be high enough to generate the sort of bullish expectations needed to stimulate demand. There’s already plenty of money in the system – we need higher spending growth expectations to push that money into circulation.”

TYR states: The author ignores the reasons behind the weakness in the economy, too much debt and misallocation of resources in the economy with some sectors overrepresented, housing and finance.

Mr. Scott Summer states: “Mark Carney’s speech on December 11 in Toronto demonstrated the growing interest in replacing inflation targeting with nominal gross domestic product level targeting, even among central bankers. The central bank would set a growth path for nominal GDP of perhaps 4 per cent or 5 per cent per year, and commit to return to that trend line when spending falls short or overshoots. Nominal GDP targeting would moderate the business cycle by being more contractionary than inflation targeting during a boom and more expansionary during a recession. And NGDP could do this while still delivering roughly the same long-run rate of inflation.”

TYR states: It is a huge mistake to assume that there is a “natural” nominal GDP growth rate, where is the scientific proof for this assumption? For centuries, GDP growth was very low, until the First Industrial Revolution speeded it up. What does that have to do with monetary policy? GDP growth depends basically on population growth and productivity, and productivity depends on availability of resources, capital and technological innovation, none of which are by any means affected by monetary policy.

Mr. Scott Summer states: “And there are many other advantages. If investors had known in 2008 that any declines in NGDP would be quickly made up, then asset prices would have fallen much less sharply, and demand would also have been more stable. The current prices of stocks, commodities and property are strongly influenced by their expected prices several years out. The severe asset price decline of late 2008 reflected the belief that central banks would fail to take decisive action to restore NGDP to the trend line.”

TYR states: Do we have to conclude that the inflated asset prices of 2008 should have been allowed to remain inflated for the sake of mantaining an arbitrarily determined nominal GDP level? In what way is this different from a centrally planned, fascist-soviet economy? What role does the cleansing mechanishm of failure have under such an economic system? This is certainly not capitalism.

Mr. Scott Summer states: “Some fear that inflation will become unanchored if we move to NGDP targeting. In fact, most of the problems that people associate with inflation are more closely linked to high and unstable NGDP growth. Wages tend to follow growth in national income. As long as NGDP growth is low and stable, wages and core inflation will remain well anchored.”

TYR states: Wages do not necessarily follow growth in national income. This has not been the fact in the last 40 years where wages have reduced their share as a percentage of GDP from 53% to 44%. It is corporate profits that have benefited the most from the covert inflation we’ve had since the USA dollar was unlinked from gold in 1971. But even if the author was right in this assumption, assume for example that we have a NGDP growth rate of 5%, an inflation rate of 5% and a wage growth of 5%…do we have any real GDP or income growth at all? No.

Mr. Scott Summer states: “A stable path for NGDP growth will also produce better policy decisions in other areas. Fiscal spending will have to be justified on a cost-benefit basis, once it is no longer expected to boost nominal demand. The cost of bailing out failed companies will be more transparent, as it will be obvious that more jobs in the rescued company are offset by fewer jobs elsewhere. Those claiming that Chinese exports cost jobs will have to provide a mechanism other than “less demand”, and won’t be able to do so. And, most importantly, countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.”

TYR states: Here the author assumes that failed companies will be bailed out (moral hazard and misallocation of resources again) and that there will be fiscal prudence just because some mumbo-jumbo cost benefit analysis will conclude that any further spending does not contribute to nominal GDP growth. Central planning, covert economic fascism again. Finally, the author seems to assume that by central banks financing government deficits “countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.”. Does anybody believe that by making deficits immune to their collateral negative effects, increase in interest rates and the associated recession, government deficits will be tackled?

Make nominal spending the new target? We hope not.

TYR 4 October 2012 reads

Spanish Prisoners @ NYT The catalan secessionist movement has sound economic, cultural and historical roots. It should be respected. In all aspects but name, Catalonia is a colony of Spain.

Chart Of The Day: The Rise Of Global Central Planning @ Zerohedge It starts like this…”there was a time when the world had (somewhat) free markets.”. The article does not contain a lot of information, but it conveys the idea with perhaps the most explanatory power in order to comprehend the present crisis: western societies are fast morphing into a neo-feudal regime, confiscatory, unelected, undemocratic, repressive, where central banks play the role of exercising the power usurped to individual citizens and democratic institutions. Behind the central banks, the real “owners” of power, a financial elite that in many ways remains hidden. The process started with the Magna Carta goes into reverse.

French Economy Implodes @ Mish’s Global Economic Trend Analysis the Markit Composite PMI sports the steepest rate of contraction since March 2009 with job losses accelerating at the fastest pace in 33 months and output plunging at the fastest rate in 42 months.

“How so? Breaking the law has now become a sort of routine”

In an interview with Die Presse, the former chief economist of the European Central Bank (ECB) discusses the latest decisions taken by this institution and asserts that from 2010 on, the ECB has given in to pressure from the outside (“Sie hat dem Druck von außen nachgegeben”). Asked about whether this pressure originated in the USA, he answered simply that it came from outside of Europe (“Druck von außerhalb Europas”).

Mr. Stark discusses the process by which the ECB, with the acquiescence of Euro zone governments has gradually loosened and finally broken its mandate, the preservation of price stability, and the huge inflationary dangers contained in its latest decisions, most specially the announcement on September the 6th of its Outright Monetary Transactions (OMT) program.

Zerohedge  comments the same interview: “…the former banker said what everyone without a PhD understands quite well: “The break came in 2010. Until then everything went well…”Then the ECB began to take on a new role, to fall into panic…. Together with other central banks, the ECB is flooding the market, posing the question not only about how the ECB will get its money back, but also how the excess liquidity created can be absorbed globally. “It can’t be solved by pressing a button. If the global economy stabilises, the potential for inflation has grown enormously… It gave in to outside pressure …pressure from outside Europe” Why, whichever bank headquartered at 200 West, NY, NY might he be referring to?”

At the end of the interview Mr. Stark, when asked about for how much longer can Germany oppose the ECB’s policies, answers: “The German Constitutional Court (GCC) has declared that the purchase of government bonds by the ECB [OMT program] collides with the rule that forbids state financing by the ECB. This leaves the Bundesbank in a conflicting position. A very difficult situation “:

Both the last question by the journalist and Mr. Stark’s answer are the most interesting part of the interview. The question goes like this: “How so? Breaking the law has now become a sort of routine”…

…and Mr. Stark’s answer: “…I would also see it this way: there is a continued collective breaking of the law”.

TYR 18 September 2012 reads

Scientific Paper: “The Fukushima Radioactive Plume Contaminated the Entire Northern Hemisphere During a Relatively Short Period of Time” @ Washington’s Blog The peer-reviewed scientific journal Science of the Total Environment reports: the Fukushima radioactive plume contaminated the entire Northern Hemisphere during a relatively short period of time.

U.S. Household Incomes: A 44-Year Perspective @ DShort Mean Household Income (MHI), adjusted for inflation,  for the bottom 50% of the population has barely increased since 1967

If You Want to Help the Poor and the Middle Class, Encourage Deflation @ Oftwhominds We have been brainwashed into believing that inflation is good and deflation is bad. The truth is that inflation is good for banks and bad for households, while deflation is bad for banks and good for households.

Why A Centrally-Planned Heroin Addiction Never Has A Hollywood Ending @ Zerohedge Morgan Stanley: When will fundamentals matter again?….Manhattan is crowded. In our judgment, sentiment is decidedly bullish. Decidedly – both on the earnings outlook and the equity market. We know everyone likes to romanticize that they are a contrarian bull on an island by themselves, but trust us, that island is not vacant. It’s crowded….We have received several emails in the last week from investors with messages of the ilk that “we all know this will end in tears”, but for now, people are not at the rehab center.

Chart Of The Day: Monetary Supply – It’s Not A Marathon, It’s A Steroid-Fueled Frenzy @ Zerohedge Gold’s supply expanded 8% while monetary bases expanded….83% (BoJ)…146% (ECB)…212% (SNB)…223% (FED)…362% (BoE)

Obama wins right to indefinitely detain Americans under NDAA @ Russia Today Pulitzer Prize-winning journalist Chris Hedges, that sued the Obama administration because of NDAA says: “this demented “war on terror” is as undefined and vague as such a conflict is in any totalitarian state. Dissent is increasingly equated in this country with treason. Enemies supposedly lurk in every organization that does not chant the patriotic mantras provided to it by the state. And this bill feeds a mounting state paranoia. It expands our permanent war to every spot on the globe. It erases fundamental constitutional liberties. It means we can no longer use the word “democracy” to describe our political system…Fear is the psychological weapon of choice for totalitarian systems of power. Make the people afraid. Get them to surrender their rights in the name of national security. And then finish off the few who aren’t afraid enough. If this law is not revoked we will be no different from any sordid military dictatorship. Its implementation will be a huge leap forward for the corporate oligarchs who plan to continue to plunder the nation and use state and military security to cow the population into submission”.

Die wirkliche Wirklichkeit

We argued in a recent post that the ESM violates Germany’s constitution and the EU treaties. Today the German Constitutional Court (GCC) ruled that the ESM and its ‘fiscal treaty’ on budget discipline do not violate the country’s Basic Law and do not undermine the Bundestag`s sovereignty over budget issues, according to Openeurope. Although the full ruling is expected in early 2013, Openeurope remarks a few aspects of today’s resolution:

  1. Cap of €190bn on German ESM contribution, which can only be overturned by the Bundestag.
  2. Both houses of German Parliament need to be adequately informed about all ESM decisions – something which needs to be enshrined in “international law”.
  3. Reinforced that Bundestag approval needed for all activations of the ESM.
  4. Explicit ban on ESM borrowing directly from European Central Bank (ECB).
  5. The German Government can terminate ESM at any time, as recognised under “customary international law”.
  6. In its full ruling, expected in early 2013, the Court will also consider whether the ECB’s bond-buying programme, the OMT, has transferred illegal degrees of sovereignty to the EU-level.

If respected, #1 ruling would limit some of the potential risks that the creation of the ESM pose to the countries (and ultimately their taxpayers) funding the ESM, most specially Germany. Effective maximum potential financial costs to Germany would be capped at 190 billion Euros, invalidating the articles of the ESM allowing for potentially unlimited liabilities.

#2 and #3 reinforces Bundestag veto over ESM activation: the decision also states that any future ESM bailouts will require parliamentary approval, stating that the Bundestag “must individually approve every large-scale federal aid measure on the international or European Union level”.

#4 bans on the ESM borrowing from the ECB: the Court says that “borrowing by the ESM from the European Central Bank” would be incompatible with EU law (Article 123 TFEU). This is a surprisingly categorical rebuke, especially over an issue of EU rather than German law.

#6 addresses not the ESM but the latest ECB asset purchase program, named Outright Monetary Transactions (OMT). The GCC suggested in its press release that the ECB’s OMT will be considered in its final ruling on these complaints. The exact criteria upon which the programme will be assessed is unclear but broadly the Court will determine whether it transfers additional German sovereignty to the European level above and beyond that which the country has committed itself to in the EU Treaties.

What does it all mean? With a firm cap on the ESM, the ECB is now most certainly the only actor with deep enough pockets to put Spain and Italy on life-support – together with the OMT announcement the ruling has shifted the burden back to the ECB. However, the ruling and the role of the Bundestag highlights that activating the OMT will be challenging, since in order to qualify for ECB bond-buying, a country must first get funding from the ESM – and be subject to conditions. If the Bundestag agrees to activate more bailouts, it will most certainly push for harsher conditions than what debtor countries – most importantly Spain – are willing to accept. In the long-term, under current arrangements of linking ESM and OMT, the latter is also effectively capped and subject to a Bundestag veto.

If this is so, the caveats in the GCC’s resolution are not minor, why did markets continue to rally today? An answer to this question is hinted in today’s Die Welt’s article, Karlsruhe weiß, wo Europas Hammer der Macht hängt, whose last sentence goes like this: “the GCC, that for us is almost as holy as the Bundesbank, is only one of the Players in the european Game, and not the most powerful one” (“Das Bundesverfassungsgericht, das uns fast so heilig ist wie die Deutsche Bundesbank, ist auch nur ein Spieler im europäischen Spiel, und nicht der mächtigste”).

If, from a german perspective, its constitutional court is not the biggest, ultimate player, who is? If, as Die Welt’s article also implies, the GCC takes its decisions not only considering Germany’s Basic Law, but also in the context of the “wirkliche WirklichkeitI”, the “real reality”, what is that reality’s content?. Mr. Thomas Schmid, the author of Die Welt’s article, hints at the European Union’s centralist drive that gradually hollows national sovereignty and places it in supranational bodies, most specially the ECB, Mario Draghi’s ECB, that does no longer fear to antagonize its most important member, the Bundesbank. The ECB, that is also supposed to be the supervisor of ALL european banks, according to the latest proposal of the European Commission (EC), emerges as an almost all-powerful institution, mostly unaccountable to national governments and not even to the European Union. What and who does the ECB stand for?. Certainly not monetary orthodoxy and price stability as is written in its charter. In whose hands does Germany’s sovereignty lay? Perhaps a review of Mr. Mario Draghi’s biography would be helpful in answering this question.