Attacking the Everything Bubble Without Killing the Economy

This article was first published by me on Talkmarkets: https://talkmarkets.com/content/global-markets/attacking-the-everything-bubble-without-killing-the-economy?post=190774&uid=4798

Mish Shedlock is a regular founding contributor to Talkmarkets. His insights are very interesting and his column here is always worth the read. I agree with him on most issues.

But he advocates similar ideas to the Fed line of raising interest rates. I think that advocacy is wrong. I believe that there are other ways of cooling the financial system, according to economist Thomas Palley, without across the board raising of interest rates.

Before discussing that, here is a look at issues that concern Mish. There are at least two reasons Mish thinks the way he does on the need to raising interest rates:

1. Mish does not believe that the Fed should commit to future booms to offset large financial busts because we already have too much asset inflation, and inflating assets more will be more deflationary in the future. That is very likely true. Janet Yellen, while following the Fed line while chairman, now advocates the Fed attempt more symmetry. Mish responded to Yellen's idea:

Former Fed Chair Yellen promotes "Lower for Longer", a policy in which the Fed knowingly keeps interest rates too low.
Here's the asinine policy proposal of the day: Fed Should Commit to Future "Booms" to Make Up for Major Busts.

This is a pretty radical idea for the Fed, and is unlikely to be implemented. It is, after all, Nominal GDP Targeting, similar to the idea espoused by Scott Sumner. But, the Fed has generally opted for an asymmetrical approach as we can see from a finding by Matthew Yglesias that I quoted in my article about Mr Kashkari:

The labor share declines during recessions and rises during booms. And the problem of the Federal Reserve is that over the past 30 years, it has a perfect track record of never allowing inflation (which is to say a sustained period in which wages rise faster than productivity), but it doesn't have a perfect track record of never allowing recessions. The inevitable consequence of this asymmetrical success is for the labor share to steadily decline.
The Fed simply is grinding wages downward. Mish is correct that asset inflation is a big problem. But fixing it before wages increase, over and over through time, has a disastrous affect on mainstreet!

2. Mish would like zombie companies to be washed out. These are the companies in the USA and Europe that depend on cheap Fed and ECB money. I have often wondered why he would want them washed out because that could be deflationary. And Mish warns of deflation often. Deflation is the result of asset inflation coupled with wage stagnation.

But Jesse Felder warns about the need to keep zombie companies afloat. I wrote about Felder:

For Felder, zombie companies crowd the stock market and will create a Minsky Moment. They are not the leaders. They are subject to speculation and could weaken under the interest rate onslaught. Just another concern regarding a Fed on the loose.
So, with points 1 and 2, Mish makes a case for wiping out zombies and and a stronger case for stopping asset inflation. Those arguments are forceful and worth studying. However, wage stagnation and wiping out zombies can be deflationary as well. There has to be another way besides interest rate hikes to contain asset inflation.

Solution to Containing Asset Inflation and Cooling Markets

Containing asset inflation while allowing wage increases and the survival of zombie companies would be a good thing. Thomas Palley came up with a solution back in 2014. We can look at it through an article at the Guardian:
The problem is that central banks must rely primarily on monetary policy to exert control over asset markets. Yes, regulation plays an important role but, as the late great Hyman Minsky taught us, the financial system is highly adaptive and central bankers require a cooling valve when they see markets getting too hot.
The article author, Philip Pilkington, goes on to show that the only way to slow asset markets has been to raise interest rates, but that there is a better way! He points to a study done by US economist Thomas Palley.
In the study, Palley comes up with an idea of controlling each market interest rate separately, without imposing that cage upon the entire system. As Pilkington says:
In such a scheme there would be additional reserve requirements for each asset class. So, there would be separate reserve requirements for stocks, bonds, mortgage securities and so on. The central bank could set these requirements at zero initially and then when they saw instability being generated in any given market they would raise the reserve requirements on that asset class. This would increase the cost of holding this type of asset and drive up the interest rate on it without directly affecting interest rates in the rest of the system.
In a system like this, Mish could have his cake and workers could eat theirs too. 
Here is what we know now. Reliance on across the board asset inflation is sure to leave out huge swaths of the population, relegating them to wealth inequality and hurting economic recovery. Economic recovery is just pretend recovery without adding prosperity to the mainstreet economy.
Under the economy we have now, we are in what Talkmarkets contributor Jesse Colombo calls the everything bubble. But wages are not in a bubble, unless we count them against developing nations. Breaking that wage bubble, if that is how the Fed looks at it, while propping up all the other bubbles, stocks, real estate, etc., has notorious effects on a disgruntled population. 
That population keeps accepting and rejecting people like Obama and Trump and the continual war boys, like Cheney and the late John McCain. 
None of those guys can fix the problem because it is not a political fix. It takes political will, however. If the politicians force central bankers to implement the fix, then wages could be protected while bubbles are popped one by one. It would not be necessary to pop every bubble at once.

NGDP Targeting has its limitations as a way to fix things. Scott Sumner is one who does not fear almost massive asset inflation. This is why Mish and others who don't want a massive bubble popping have trouble with NGDP Targeting. Even the Council on Foreign Relations weighed in:

We think the (NGDPT) rage will be short-lived. The reason is that NGDP targeting’s newest supporters are bad-weather fans. That is, they like it now, when NGDP is well below its 2007 “trend” line, meaning that the policy implies extended and more aggressive monetary loosening. But what happens when NGDP goes above its target, as it eventually will? NGDP targeting then requires tightening, even if inflation is low – it may even require a deliberately deflationary policy stance.
Well, it isn't short lived if Yellen recently said this:

Elaborating on how the central bank should think about what to do if rates have to be cut to zero again in the future and can’t go any lower, she said the Fed should promise now that it will keep rates low enough to let a hot economy make up for lost time.
Whether you like the idea of NGDP Targeting or not, a symmetrical approach to monetary policy seems more fair. But the Fed is procyclical, reining in bank lending if there is a whiff of adversity, and is assymetrical as I have said, always pushing wages down, opting for recession over inflation. 
Now the Fed is in the process of popping the bubbles all at once. Dire consequences for workers will follow. It could be deflationary in the way that Mish Shedlock rightly abhors. This, according to Mish, is where we are at now:
  • What's left on the inflation side is mostly what's happening right now: Late stage inflation.
  • What's left on the deflation side is mostly long-term secular deflationary forces.
  • Asset bubble burstings are deflationary by definition.
We face a grim future unless economist Palley's ideas are seriously contemplated and applied. Real estate could be popped while stocks and wages and rates for businesses could remain stable. At that point, dealing with the stock markets of the world could become center stage, but not while the world economy and the American worker are suffering. Anything is better than the heavy Fed hand pummeling all markets at once. That will result in world economic slowdowns that could result in unnecessary suffering.








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