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Saturday, January 29, 2011

Arthur Laffer: “Get Ready for Inflation and Higher Interest Rates”

June 11, 2009
by Will
Writing in the Wall Street Journal, Arthur Laffer, chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy — If We Let It Happen”, has written what I think is a very perceptive essay on Get Ready for Inflation and Higher Interest Rates.  As one who remembers the 1970′s quite well, I think he is “on target” in this assessment:
It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S. To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges. It wasn’t a pretty picture.
If it could be worse than the economic situation we had during the Carter administration, I would say we certainly do not need to be taking the course we are now taking with the economy!

4 Comments leave one →
  1. Betty Wingo permalink
    June 21, 2009 3:09 am
    Background:
    Art Laffer is a professor of Economic’s at USC. He was an economic advisor to President Reagan and along with Jack Kemp was a leading advocate of “Supply Side” economics and was a favorite of Larry Kudlow who is fellow “ Supply Sider”. Professor Laffer was the creator of the “ Laffer Curve” which demonstrated conclusively as rates of marginal taxation on capital are reduced total aggregate tax paid to the government rises.
    Points to consider:
    1. Laffer actually understates the inflationary impact of the expansion of the monetary base. The fractionalized banking system allows for 9 dollars of loans for each dollar of capital. In addition he fails to mention the multiplier effect on the loans made, this is not surprising as he is a non Keyensian and the multiplier was a key innovation developed by Keyens in his General Theory. Laffer also fails to mention in such an inflationary atmosphere the Velocity of money or Turnover greatly increase.
    2. When the amount of expansion of the monetary base is considered the expansion of the money supply (M1) at 15% is not as dramatic as it should be. It could be surmised that this is due to a dearth of quality loan opportunities exists now. Households are contracting their finances so there are not qualified opportunities to lend. The banks therefore leave large amounts of capital on deposit at the Fed where they are now paid interest which generates a positive yield spread helping to strengthen Balance Sheets. This is a situation that eventually will change! As the banks begin lending this ocean of money must go someplace. It will be inflationary.
    3. The final point to consider is that what Laffer describes in the U.S. with the Fed is going on all over the world. Central banks everywhere are rapidly creating new money supply as is the I.M.F. on a global basis – This indicates devaluation of all currencies, some faster relative to others such as the Dollar V.S. the Yuan as example. In esscence you have a race for the bottom.
    • June 21, 2009 9:03 am
      Thank you for your most informative – and well thought out – comment. From what you say (if I am understanding correctly) it appears Laffer may be UNDERSTATING the possible inflationary impact. I have to say that is a scary thought.
      In your last paragraph you mention “a race to the bottom” in devaluation of *all* currencies. I know that in the Weimar Republic with their hyperinflation it was localized there, and the same thing would be true in Zaire now. Would you happen to know: has there ever been anything close to a world hyperinflation? Did the existence of the gold standard prevent such a thing from happening?
      • Betty Wingo permalink
        June 23, 2009 1:34 am
        Will,
        Your understanding is correct. I believe that Laffer understates possible inflationary impacts in his article.
        In answer to your question about world wide hyperinflation: Upon reflection I cannot think of a incidence in modern times. Most “Weimar” type of inflations have taken place on a national basis – Nationalist China, Russia (a couple of times), Indonesia, Malaysia, Mexico, Argentina ( again more than once). I would say a regionalized type of inflation has existed on a hyper basis several times with a group of South American Banana Republics at the same time. On a more historical basis Europe during the Napoleonic Wars had hyperinflation to finance their war. The Roman controlled world (The Roman Empire) experienced inflation when Rome debased their coinage.
        Thinking about these cases of hyperinflation caused me to realize something common to all in modern times. The hyperinflation was a prelude politically the rise of “ Strongman” rule in almost all cases. Hilter in Germany, Sukarno in Indonesia, Peron in Argentina – Military Juanta’s in Chile and Latin America, Chang and Mao in China, and variours strong man dictators in Africa. (Zimbabwe, Zaire and numerous others) This may have ominous implications for the future.
        One final thing to remember when we and Laffer discuss inflation rates, we are talking about official government rates based on official rates of exchange. Many parts of the developing world have an active “Black Market Economy” where most of the common people do their daily transactions. So it would be quite possible for official rates to be far below “ Black Market” rates that could be hyperinflationary.
  2. June 23, 2009 2:31 pm
    Thanks yet again for such insight. I had not known about the inflation in several of the places you mention (such as Nationalist China) and if that is the case it truly does seem to be a parallel to the rise of Hitler after the Weimar Republic. As you say that is ominous for the future.
    One of the more troubling aspects of this for me is that unlike the 1930′s when we were more rural than we are now (and hence had better access to food locally), now as a society it seems that we are far more interdependent on outside sources of food. This will not be a good thing if the global economy has much of a breakdown at all.

Sunday, January 23, 2011

Book review of "Game Over"

Reading “Game Over” made me think of a similar thesis over 300 years ago.  Thomas Malthus a classical economist – Before there was the subject of Economics described a situation that existed in long ago Europe.  He put forth that the food supply of the world grew on an arithmetic basis while population grew on a geometric basis.  Malthus felt this foretold dramatic declines in population due to wars, disease, and famine.  So the “Mathusian Dilema” put forth in “ Game Over” is not a new one.

It is clear that the populations of India and China will not be able to live the middle class life style of the average American – Not enough raw materials exist unless some sort of technological breakthru takes place on a huge order.

The book caused me to reflect upon a situation in the past when a rising industrial power was being restrained in it’s desperate search for raw materials to feed it’s factories – Japan in 1941 – This desperate need for raw materials caused a miscalculation on a political and military basis that had terrible consequences for Japan and the rest of the world – Yet provided the spur for the technological leaps forward – (nuclear power, jet aircraft, missile technology etc…).   One can only guess where such a miscalculation would lead us today.
Wingo’s Economic Outlook 2011


1.     After early promise of recovery it will become apparent that the recession has deepened and spread out in the economy.

2.     U.S. unemployment will continue to linger at a high level with U.S. rate hitting 11.5% and California over 14%.

3.     Japan will take steps to cause the economy to expand, these attempts will fail and Japan will lose manufacturing business to China.  The Japanese economy will continue to be mired in deep recession.


4.     The China bubble will burst with a large Real Estate bust with dramatic effects for industrial commodities.

5.     Russia will show effects of high inflation and a flight of capital.

6.     After a false signal upward U.S. Auto makers’ will be battered at the lower end car market will continue to show gains by low cost Korean car manufactures.  Fiat will also show some gains in small car segment.


7.     There will be a revolt by air travelers against restrictive security measures.  As a result airlines will have a softening of business.

8.     California under new leadership will choose to cut programs severely rather than raise new taxes. – This will result in State job layoffs and shift of power to county, city level.  Bond defaults loom.

9.     Announcement of proposals to reform Fannie, Freedie will be made but little substantive change will happen.  Loss from GSE’s  will become astronomical as forecloses boom.

10.  Commercial Real Estate losses will become major R.E. story in 2011        as loans cannot be rolled over.


11.  Banks will continue to fail especially smaller community bank’s in           excess of 150,  FDIC will need bail out from government.

12.  Major State will default on debts!

13.  Further reduction on Santa Barbara Real Estate high end will be hit very hard.

14.  Government deficit will continue unabated National Debt approaches 16 trillions.

15.  Total Real Estate losses will be in excess of 8.5 trillions from peak.

16.  Minor European nations-(Italy, Spain, Portugal, Ireland) will default.  One major European nation- (France, U.K., Germany) will get very shakey.

17.  One major money center bank will be recognized as insolvent.

18.  Oil will cross 120 per barrel, gasoline will go to $4.35 per gallon before declining due to China bust.

19.  Gold will cross $1,900 an oz and Silver $42 an oz.


20.  DJIA – Low 6,200  High 12,400  Close 7,500.

21.  U.S.$ :Yen = 1:62 – Euro parity – Korean Won up to 20% against U.S.$ -South African Rand up  18%.