Higher Taxes, Inflation, Default (Choose One)

I am a mix of analysis and intuition. Few argue with my analysis, a decent number argue with my intuition.  But I am not the only one concerned about monetary policy.  Listen to Warren Buffett (pages 12-16, but he comments elsewhere on the cost of capital and the inability to compete on an unlevered basis because of low rates.  Buffett is uncomfortable with the idea that the Fed can expand its balance sheet indefinitely.  He doesn’t know why it won’t work, but he knows that there are no free lunches, and wonders what might happen as a result.

Or, read this piece that disses quantitative easing.  Truth, there is no easy transmission mechanism between quantitative easing and employment.  It is a fools game, and when I say that, I say that neoclassical economists are sophomores, that is, “wise fools.”

Are they bright? Yes.  Have they imbibed dumb ideas that have a patina of intelligence? Yes.  Too much private debt leads to banking crises.  Too much public debt leads to worries over higher taxes, inflation and default, which inhibits private action, leading to a slower economy.

The Federal Reserve has discovered that they have a real balance sheet.  They not only have a liability policy, as in the old days, but they have an asset policy, allowing them to take on pseudo-fiscal stimulus.  Sadly, the idea that a central bank should not take asset risks is out the window.

Just as the referendum process makes legislators lazy, in the same way delegating economic policy to a central bank makes legislatures lazy — they can do nothing, and let the central bank react.

Part of the problem here is that we are relying on the models of the economists who argued that debt is neutral, and could not see the crisis coming.  Debt is the problem.  Debt-based systems are inherently inflexible and lead to crises when they are too big.  All significant economic crises are debt crises.

We need to get the neoclassical economists out of the Fed.  They can’t think broadly enough to see the problems we are in.  We need people who can think long-term, like actuaries and value investors.  (Please tell the SOA, CAS, and CFA Institute to rid their curricula of neoclassical economics.)  There is enough intelligence in those two groups that a new theory of what to do could emerge, perhaps realizing that optimizing the short-term ruins the long-term, and vice-versa — sometimes you have to take a depression to realign your economy.

In general, the US Government has not displayed any real talent in managing the economy.  If I could rewrite the Constitution, I would limit the Federal role in matters economic, and eliminate the possibility of a central bank.  Even when it did work well under Martin and Volcker, it does not make up for Greenspan, Bernanke, Burns, Miller, Harding, Crissinger, and Young.

I would also require balanced budgets on an accrual basis, ending the problems of non-funding Social Security and Medicare.  The problem of promises now, performance later will bite us hard, and most of the rest of the world also, because changing old age security from a personal issue to a collective issue has this problem: there is no reason for any husband and wife to have more children.  This is hitting the rest of the world harder than the US, because the (mostly dead) Protestant optimism of the US leads people to have more have more children. (Please remember that the group in history that had the largest completed family size was not the Catholics or the Mormons, but the New England Puritans, who averaged 9.5 children in families where the wife survived.)  Also note that Puritan husbands cared for their wives deeply.

As for me, my wife and I bore 3 children, but not for lack of trying for more.  We never used birth control.  We also adopted 5, sending us through the social work system 5 times.  It is challenging to raise a large family, but it was worth it.  We are on the receding side of it, with our youngest now aged 10.  The challenge of raising older children is significant.

Um, I got off-track.  The grand scheme is that many think that they can borrow big in the present, and it won’t have any significant consequences in the future.  That idea will fail in some way in the future, but how it fails is an open issue.

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About David Merkel 145 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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