Unforeseen Contingencies

and Unforeseen Contingencies can explain why!

A good friend of mine asked what I think of the comment by Paul Krugman in today’s New York Times. Krugman is commenting on the Fed’s (allegedly temporary) taking on of mortgage debt. I think Krugman is completely wrong, but wrong in a way where he'll still be able to say "see, I told you," almost no matter what happens.

The Fed isn't buying risk. It is buying losses. The serious research shows home prices are going to fall further, and the banks know it and the Fed knows it.

The "government" will absorb the losses - the citizens will, that is - and the bigger banks will get off the hook. The announcement by the Fed a few minutes ago that it will bail out Bear-Stearns only confirms this...

"privatize the profits, socialize the losses."

Krugman doesn’t mention the moral hazard effects of the bailout. Responsible financiers who were conservative and hence took less profit suffered in the boom, and the risk takers took profits. Now that the Fed bails out the risk-takers, any financial incentive to be responsible is eliminated - at least if you’re "too big to fail."

Krugman doesn't mention the effect of the Fed's continual expanding of the money supply: the dollar continues to become less valuable, i.e. domestic price inflation and further collapse on forex markets. That is, and please excuse the strong language, the dollar is being sent to hell. Ken Rogoff (former IMF chief economist) has just pointed out that inflation is growing in the U.S. and around the world precisely because central bankers, and *especially Bernanke*, have stopped making low inflation the priority.

I have been wondering why the Fed seems to have given up on fighting inflation. I can't account for Greenspan (probably some explanation involving short range political expediency), but Bernanke seems to have said in a ceremony honoring Friedman something like "Milton, you were right about the Great Depression: we've learned this, and we'll never let it happen again."

He was referring to the Friedman-Schwartz research that showed that the Fed triggered the 1929 and 1938 collapses by restricting the money supply. So he'll NEVER restrict the money supply, because every problem is a potential Great Depression? I think that's it. He's an inflationist.

He has the "core inflation" hokum on his side in pitching this nonsense. Supposedly gas and food prices have more volatility, and hence in a time when they are bouncing around for reasons unrelated to inflation it might make sense to exclude them. But this isn't the case here. For most people food and gasoline are necessities (hard to believe it's necessary to point this out, but apparently this is omitted from Bernanke's blackboard models). Inflation is worsening, and consumers are bearing the brunt.

(As I pointed out previously, in his recent testimony before Congress Bernanke pointed out that while gas & food prices are spiraling up, prices for apparel and financial services are unusually soft -- great, "let them eat Gucci... and services of the inventors of Collateralized Toxic Waste.")

Back to Krugman, he doesn't explain why increasing the money supply can "work magic." It's only in a limited circumstance in which there's substantial unemployed resources and a liquidity dearth...Bernanke's view of every situtation, I guess. Krugman seems to have stopped explaining economics and only is interested in promoting politics - unfortunate, because explaining econ is the only thing he's good at.

In sum, I think we'll see continued Fed bailouts of the banking sector, money expansion and inflation, increasing federal deficits, credit market malfunctions, recession, and... the destruction of the dollar. The current Fed policy ought to be criminal, and the Fed ought to be eliminated and replaced with a free market monetary system. But power and wealth of the beneficiaries, I don't expect to see that happen soon. Instead - more of this planned chaos. Ugh.

On that happy note, I'll close...