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(email exchange)

Thanks, this is yet another example of the WSJ publishing and thereby promoting authors with no understanding of monetary operations, which means the WSJ editors don’t have any either.

Feel free to send this along the the WSJ with your own introductory comments as well!

>   This is a well written piece, by Mr. Wood of CLSA.

I respectfully don’t agree.

>   He has long maintained a bearish bias which comes through in the
>   article. The points he raises I believe are cogent and logical and ones I
>   have addressed as well over recent days and months.

It doesn’t seem you understand monetary operations either.

>   The end of the article discussing gold I found to be particularly of
>   interest.

The Fed Is Out of Ammunition: A Discredited Dollar Is a Likely Outcome of the Current Crisis

By Christopher Wood

With an estimated $4 trillion in housing wealth and $9 trillion in stock-market wealth destroyed so far in the United States, there is little doubt that we are witnessing a classic debt-deflation bust at work, characterized by falling prices, frozen credit markets and plummeting asset values.

Yes, as well as fiscal automatic stabilizers working their way to the rescue as always.

Those who want to understand the mechanism might ponder Irving Fisher’s comment in 1933: When it comes to booms gone bust, “over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money.”

Irv was writing in the context of the gold standard of the time, and that did very well.

But it’s inapplicable with today’s non convertible currency and floating FX.

The growing risk of falling prices raises a challenge for one of the conventional wisdoms of the modern economics profession, and indeed modern central banking: the belief that it is impossible to have deflation in a fiat paper-money system.

You can easily have deflation if the deficit is allowed to get and remain too small.

Yet U.S. core CPI fell by 0.1% month-on-month in October, the first such decline since December 1982.

Pull back in commodity prices mainly, after a long run up, but yes, for now the moment the outlook is deflationary.

The origins of the modern conventional wisdom lies in the simplistic monetarist interpretation of the Great Depression popularized by Milton Friedman and taught to generations of economics students ever since. This argued that the Great Depression could have been avoided if the Federal Reserve had been more proactive about printing money.

On the gold standard this might have worked, though it would have meant the need to rapidly devalue the conversion rate which would have considered a government default. And this did happen.

Today it is inapplicable with non convertible currency and floating FX.

Yet the Japanese experience of the 1990s — persistent deflationary malaise unresponsive to near zero-percent interest rates — shows that it is not so easy to inflate one’s way out of a debt bust.

Doesn’t show that at all. Just shows the depth of their reluctance to use sufficient deficit spending to restore output and employment via increased domestic demand. They want to be export driven and have paid the price for a long time.

In the U.S., the Fed can only control the supply of money;

No, it only can control the term structure of risk free interest rates.

it cannot control the velocity of money or the rate at which it turns over.


The dramatic collapse in securitization over the past 18 months reflects the continuing collapse in velocity as financial engineering goes into reverse.

By identity.

True, this will change one day. But for now, the issuance of nonagency mortgage-backed securities (MBS) in America has plunged by 98% year-on-year to a monthly average of $0.82 billion in the past four months, down from a peak of $136 billion in June 2006. There has been no new issuance in commercial MBS since July. This collapse in securitization is intensely deflationary.

Yes, though offset by increased government deficit spending, increased export revenues (for a while), and increased direct lending by banks to hold in portfolio (which is how it was all done in not so distant past cycles).

It is also true that under Chairman Ben Bernanke, the Federal Reserve balance sheet continues to expand at a frantic rate, as do commercial-bank total reserves in an effort to counter credit contraction.

In an effort to lower rates and thereby counter credit contraction.

Thus, the Federal Reserve banks’ total assets have increased by $1.28 trillion since early September to $2.19 trillion on Nov. 19. Likewise, the aggregate reserves of U.S. depository institutions have surged nearly 14-fold in the past two months to $653 billion in the week ended Nov. 19 from $47 billion at the beginning of September.

So??? Just entries on a government spread sheet with no further ramifications.

But the growth of excess reserves also reflects bank disinterest in lending the money.


This suggests the banks only want to finance existing positions, such as where they have already made credit-line commitments.

Banking is necessarily pro cyclical- get over it!

Monetarist Bernanke and others blame Japan’s postbubble deflationary downturn on policy errors by the Bank of Japan.

Not me. It was the lack of sufficient deficit spending, as above.

But he and others are about to find out that monetary gymnastics are not as effective as they would like to think. So too will the Keynesians who view an aggressive fiscal policy as the best way to counter a deflationary slump. While public-works spending can blunt the downside and provide jobs, it remains the case that FDR’s New Deal did not end the Great Depression.

Mixing metaphors. The New Deal’s deficit spending was far too small to restore output and employment.

There are no easy policy answers to the current credit convulsion and intensifying financial panic — not as long as politicians and central bankers are determined not to let financial institutions fail, and so prevent the market from correcting the excesses.

Yes there is an easy answer- make a sufficiently large fiscal adjustment.

This is why this writer has a certain sympathy for Treasury Secretary Henry Paulson, even if nobody else seems to. The securitized nature of this credit cycle, combined with the nightmare levels of leverage embedded in the products dreamt up by the quantitative geeks, means this is a horribly difficult issue to solve.

Couldn’t be easier. Start with a payroll tax holiday where the treasury makes all FICA payments for employees and employers.

The spread around a few hundred billion in revenue sharing to the states for operations and infrastructure.

Crisis over.

Virtually everybody blames Mr. Paulson for the decision to let Lehman Brothers go. But this decision should be applauded for precipitating the deflationary unwind that was going to come sooner or later anyway.

The Japanese precedent also remains important because the efforts in the West to prevent the market from disciplining excesses will have, as in Japan, unintended, adverse, long-term consequences.

Doesn’t even mention output and employment.

In Japan, one legacy is the continuing existence of a large number of uncompetitive companies which have caused profit margins to fall for their more productive competitors.

Who cares?

Another consequence has been a long-term deflationary malaise, which has kept yen interest rates ridiculously low to the detriment of savers.

Interesting bit of logic!

Meanwhile, the most recent Fed survey of loan officers provides hard evidence of the intensifying credit crunch in America. A net 83.6% of domestic banks reported having tightened lending standards on commercial and industrial loans to large and midsize firms over the past three months, the highest since the data series began in 1990. A net 47% of banks also indicated that they had become less willing to make consumer installment loans over the past three months.

Banks are necessarily pro cyclical- get over it!

Consumers are also more reluctant to borrow. A net 48% of respondents indicated that they had experienced weaker demand for consumer loans of all types over the past quarter, up from 30% in the July survey. This hints at the Japanese outcome of “pushing on a string” — i.e., the banks can make credit available but cannot force people to borrow.

Good! Lower taxes for any given amount of government spending. Bring it on! Now!

The Fed Is Out of Ammunition

With a fed-funds rate at 0.5% or lower in coming months, it is fast becoming time for investors to read again Mr. Bernanke’s speeches in 2002 and 2003 on the subject of combating falling inflation. In these speeches, the Fed chairman outlined how policy could evolve once short-term interest rates get to near zero. A key focus in such an environment will be to bring down long-term interest rates, which help determine the rates of mortgages and other debt instruments. This would likely involve in practice the Fed buying longer-term Treasury bonds.

Yes. And not do a lot for output and employment until fiscal adjustment takes hold.

And do we really want to encourage an increase in private leverage? Been there done that, right?

It would seem fair to conclude that a Bernanke-led Fed will follow through on such policies in coming months if, as is likely, the U.S. economy continues to suffer and if inflationary pressures continue to collapse. Such actions will not solve the problem but will merely compound it, by adding debt to debt.

I think he’s got it right there.

In this respect the present crisis in the West will ultimately end up discrediting mechanical monetarism —

Hope so. It flies in the face of theory and reality.

and with it the fiat paper-money system in general — as the U.S. paper-dollar standard, in place since Richard Nixon broke the link with gold in 1971, finally disintegrates.

Why??? Deflation as above? Deflation is the increase in value of a currency. Disintegration is via inflation???

The catalyst will be foreign creditors fleeing the dollar for gold. That will in turn lead to global recognition of the need for a vastly more disciplined global financial system and one where gold, the “barbarous relic” scorned by most modern central bankers, may well play a part.

Fleeing the dollar for gold means inflation. He’s been preaching deflation for this whole piece. Can’t have it both ways.

Mr. Wood, equity strategist for CLSA Ltd. in Hong Kong, is the author of “The Bubble Economy: Japan’s Extraordinary Speculative Boom of the ’80s and the Dramatic Bust of the ’90s” (Solstice Publishing, 2005).

Aha! Hong Kong has a fixed FX policy, much like a gold standard. He’s applying fixed FX analysis to the us which has a floating FX policy.

The WSJ should have told him this and rejected this op-ed piece.


31 Responses

  1. The news is out! We have been in a recession for a year now?! How do economics fix the whole country out of cash? (Regular people) And they just limited out there credit cards on fuel in the last year getting to work, if they are lucky enough to have a job. Not to mention they just voted in another joker corporate slut to help fascism move along smoothly.

    They can’t print enough to keep up, the dollar is on its way out and we are likely going to see the amero or even some world currency soon?

    The Fed is a Corrupt Criminal organization bleeding the world for greed of power! Time to listen to Ron Paul and END THE FED!!

    The time for half measures and talk has come to an end!

    However the American People are soo dumbed down they will hardly notice ontill it is way too late, Warren you got a good spot to watch from!

  2. Warren,

    The problem is, a lot of people think like this guy does, including top policymakers. Ron Paul raised quite a lot of money in his run for the presidency, and he pushed for a return to a gold standard. Recent comments from Volker, Paulson and many others clearly show their thinking: that the U.S. is constrained in its ability to solve this crisis and that the Fed “caused” this by keeping interest rates too low.

    Moreover, the new administration is replete with deficit hawks and the Fed has shown an inclination to target the dollar’s exchange rate at some level.

    So while these people are all “off paradigm” that does not preclude policy fashioned along the lines of their thinking.

    Often times, perception is reality.

  3. I don’t think gold-standard guys like Christopher Woods think in terms of fixed vs. floating FX, they think in terms of fiat (fixed or floating) and non-fiat (gold, primarily), obviously preferring the latter.

    In fact, if given a choice, in a fiat world most hard currency guys favor floating FX. Fixed fiat represents the worst of all possible worlds to them – paper money and price controls, despite the restraint it puts on fiscal policy. In their eyes, the central bank is the real monster and it is monetary policy that needs the most restraint.

    Austrian economists, for example, were strongly against the Bretton Woods system and the gold-exchange standards of the early 20th century because they saw them as “phony” gold standards that required both fiat money and a central bank to manage the price.

    So it’s not about the logic or reality of monetary operations; it’s about political ideology, a much tougher nut to crack. For Christopher Woods that would require an exorcism of his libertarianism.

  4. Mike, you’re really getting good at this stuff!!!

    Knapp, good points!

    Of course, Mike and I are the true libertarians…

  5. Warren:

    I’ve learned a tremendous amount on your site. One element I still cannot understand is how government deficits are necessary for (net) private saving. I understand how this works as an accounting identity, but I cannot get my head around what this means in real life. Should their be any limit on Government deficits? Are larger deficits always good? Is there any situation in which the Federal Government should run a surplus?

    I understand the account identities, but I cannot see how an ever increasing deficit can, long term, keep the currency from losing too much value via inflation and being abandoned (as it is in many third world countries) or help the country make better investment decisions and thus increase real goods and services available.

    Please help me out!

  6. Yes true libertarians. Me too.

    To me, coming from a hard money background, Soft Currency Economics at first reads very socialistic(loans create deposits! employer of last resort!! money as a tax credit?? fiscal policy as unconstrained?)but then once I got the paradigm, the policy implications started to seem very libertarian, for example, by shrinking Wall Street to a fraction of its current human-capital-draining size through the elimination of various policy arb opportunities. Now that’s the sort of productivity a libertarian can embrace.

    Of course, most hard-money reactions to your paradigm go something like this:


  7. Zanon,
    The federal government should use the deficit as a tool to target desired levels of aggregate demand. If aggregate demand exceeds productive capacity resulting in inflation we can raise taxes and reduce the deficit. Also, note, supply-side factors such as crude oil supply effect inflation and economic policy counter-measures should be taken to limit demand for crude.

  8. Knapp . . . thanks for the most interesting link. Closest I’ve ever seen an Austrian get to understanding that loans create deposits, perhaps because he was reading some of Randy’s stuff. It’s always so puzzling that they consider the cb as the root of all evil, even here, when out of necessity the cb sets an interest rate target in a fiat money system without gold or other currency board backing. Also, no understanding that gold standard or currency boards would have difficulty with even simple payments crises (compared to, say, current difficulties) like Y2K or 9/11.

  9. Scott,

    Just doing my part to bring together the Hatfields and the McCoys;)

    Frank is a friend, I sent him Randy’s stuff a few years back after my own discovery and realization that the Austrians were ascribing powers to the Fed they did not possess.

  10. And of course, there is ample historical evidence that the free banking scenario he posits simply doesn’t work in practice. The U.S. in the later 19th – early 20th centuries lurched from banking crisis to banking crisis, each one worse than the one before. If all you’ve read is “The Creature from Jekyll Island”, you think that everything was peachy until some eeevil bankers dreamed up the Fed in a plot to contaminate our bodily fluids, but unfortunately real life isn’t like that.

  11. The second link is interesting, and points to the primary weaknesses in Austrian analysis. (Which it shares with most orthodox neoclassical approaches – in fact, one could say for the Austrians that they are at least wrong in a consistent way, while the mainstream constantly find new and better ways to be wrong…)

    The weakness is that the economy he posits is one of pure exchange in which all production is already accomplished, and all that is needed is to distribute the goods. While this meshes well with the Walrusian models, real economies have both a past and a future. Production takes time, and thus finance and money “created out of thin air” is necessary to “borrow from the future”. Once you understand this, you realize that every producer is in fact a gambler in a casino where the odds are constantly changing. Those neat and elegant Walrasian equations simply don’t apply…

  12. Jim,

    Austrian are the harshest critics of the time-less, change-less walrasian economics that you ascribe on them:


    Real time and uncertainty are major parts of the Austrian paradigm, and the areas where it has the most in common with Post Keynesianism.

    That “Production takes time” is repeated in just about every paragraph of every Ausrian research paper.

    They are just working off of a savings-constrained, commodity money, no-factional-reserve model, where deposits create loans, and by force of logic, production precedes consumption, i.e. Say’s Law.

    That model might not reflect today’s monetary system, but it has nothing to do with time-less Walrasian general equilibrium models.

  13. Knapp,

    Hmm, I stand corrected. I must confess I have never had too much interest in the Austrians (a predudice, I freely admit, that has more to do with the type of person one finds advocating them than in a sober analysis of their ideas…) On reading the last article you posted I was struck by the backward-looking savings constrained model, and assumed that it entailed a static view. My bad. (I would promise to read more, but I don’t think I could stand it. Krugman is bad enough, and he at least claims to be a Keynesian!)

  14. Yes, lots of common ground with Austrians in critiquing Walrasian GE, DSGE, and other aspects of the neoclassical methodological approach. As both Jim and Knapp note, primary disagreement is between the concepts of exchange economy vs. monetary economy. But this is a more interesting conversation, because we can talk about what the economy of experience looks like, whereas, neoclassicals often can’t distinguish between reality, methodology, and technique. Similarly, it’s often more interesting to engage fans of, say, Fischer Black on, say, Minskyan instability, financial markets, and the monetary system, than it is to engage neoclassicals on these issues.

    I’ll look at the Minsky post when I have more time. Thanks for posting it.

  15. Z- if the deficit exceeds ‘savings desires’ it’s ‘inflationary’
    one way to minimize that is to have the govt spend on a ‘price constrained’ basis at the margin, as in ‘full employmnent and price stability’ on this website.

    K- agreed, and Frank misses the nuance that an overdraft at the fed is a loan from the fed, so the fed is ‘passive’ in accomodating reserves and only alter interest rates- it’s about price, not quantity

    J- yes

    S- yes

    12. Frank’s totally confused with that Minsky article, particularly with his own ‘savings’ model, etc. Particularly when he adds ‘money’ and says it doesn’t change anything, without defining what is meant by ‘money,’ as if any ‘money’ would give the same result.

  16. Warren:

    I’m sorry I’m being dense about this, but if you have a link to a recommended reading about why the government running a fiscal deficit is *necessary* for net private savings, that would be great.

    I’ve read almost all of the “mandatory readings” on your site and don’t have a good understanding of this.

    China, I believe, runs a fiscal surplus and has positive net private savings. The US, OTOH, runs a fiscal deficit and has negative net private savings.

    The claim that the current slump is an extension of the rubin/clinton surplus years is certainly eyebrow raising!

  17. Zanon

    If I may, I would suggest a few things. First, there’s a brief discussion on this in “the natural rate of interest is zero,” and also the discussion of NFA in “full employment and price stability” is referring to net saving.

    The most recent thing I can find that goes into detail is here . . .


    Randy Wray, Wynne Godley, and Dimitri Papadimitriou at the Levy Institute have published a lot of stuff (sometimes together, sometimes separately or with different co-authors) on their website on this issue since the late 1990s.

    The basic equation, an accounting identity from national income accounting, is

    net private saving = government deficit + current account surplus

    Thus, a country with a current account surplus larger than a government surplus can still have positive net private saving. Be careful, though, with mainstream media or even mainstream economics discussions of “saving” or “savings” in the US or other countries, since they often count investment spending by businesses as saving (gold standard paradigm where saving funds investment), whereas the above concept of private net saving would subtract all private domestic spending by firms and households, along with taxes, from income.

    Much more could be said, but I’ll stop there for now. Warren can get at the heart of the issue with far fewer words than I do anyway.


  18. This guy? Dudes?

    Yes the fed caused this, however, you are not giving enough credit to the true mess we are in and why?

    Too much nepotism, cronyism, and down right greed! No way should John Q have to pay many times the original cost of his home over half of his life! How about a fair lending system that allows Johnny to pay off his loans with out a zillion slackers sitting behind their desk taking his cut!

    The monster is too big with a huge appetite!

    This is down right scary! Did these guys do 911?

    Warren, just think how many Johnnys could afford a MT911! I know I would buy one!

  19. Bit off topic but…

    The states are facing a huge fiscal crunch right now. Why isn’t the federal govt stepping up to provide money to the states?

    I’m sure the state spending is ready to go. All they need is the money. Seems stupid not to cover their shortfalls. Certainly would have a more immediate impact than new capital improvement spending (though I’m sure a lot of state spending is capex).

  20. Rich:

    Looks like Obama wants to do something; he and the others seem to still be too focused on debt to do enough, though. They quote Obama at the end of the article saying “We’re not as a nation going to keep being able to print money”. That mindset doesn’t bode well for prospects of extensive revenue sharing. Perhaps he should check out the articles on this site. I’m happy that they’re looking at a bottom-up approach, at least.

  21. Yea, they do seem committed to some substantial deficits for the next two years at least. Volker’s probably gonna need CPR if it happens though.

    Anyone else tired of hearing the phrase “print money”?

  22. next thing they’ll do is crown bernanke the ‘Prints of Money’???

    sorry, been in australia too long. got 10 more days here. and not much email access next week.

  23. Warren

    In Australia? Are you doing any public speaking engagements? I’d like to come along and listen if possible.


  24. did 20 min at univ of newcastle for bill mitchell’s conference. then off to a friend’s wedding and a boat ride. home soon!

  25. Mishkin reponds: Fed Still Has Plenty of Ammunition:


    Mishkin quote:
    “The fact that monetary policy is more potent than during normal times argues for even more aggressive easing during financial crises.”

    A Neoclassical view that ascribes more power to monetary policy than it actually has, a view that is only marginally different than his target, Christopher Woods. Both think that monetary policy is very potent during normal times, Woods less so during a crisis.


  26. yes, but at least he does seem to be (very) slowly coming around:

    Even though the Fed’s liquidity injections, which have expanded the Fed balance sheet by well over a trillion dollars, have been extremely useful in limiting the negative impacts of the financial crisis, they have not been enough. A fiscal stimulus package is needed to keep the U.S. economy from entering into a deep recession. The $500 billion question is whether the fiscal package can be done right so it has the maximum impact in the short-run but does not lead to future tax burdens that are unsustainable.

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