Mish vs Fed: Who’s Right About the Economy?

Ludwig von Mises warned about being over-reliant on index numbers when assessing economic conditions.  Not only are they often subject to political manipulation (e.g., inflation numbers, GDP numbers, unemployment numbers), but they are subject to simple human error.  This aversion for bureaucratically determined index numbers played no small role in his rejection of even the possibility of having a centrally planned monetary and/or economic system. Even if governments were not prone to debauching the currency and then lying about the degree to which they had done so, they were unlikely to be able to consistently measure that inflation, never mind manage the financial machinery towards desired ends.

As George Cooper has demonstrated—if the history of the Fed has not convinced you already—central banks regularly make a hash of things.  Hitting the gas when they should be hitting the brakes, and hitting the brakes when they should be accelerating.  Or, if they take the correct action in the abstract, their lack of nuance only serves to amplify the inherit instability of credit.  Cooper argues that the central bank can avoid these problems by conducting “fire drills” wherein central banks randomly raise rates to see who has been swimming naked, to mix metaphors.  One can think of it as a kind of controlled fire to prevent a catastrophic forest fire.  Even the possibility of a sudden hike in rates—100 basis points, for example—would make banks wary of engaging in the kind of nonsense that culminated in the subprime mortgage extravaganza.

I am afraid that, like many of the gold bugs, Cooper underestimates the necessity of cheap money in our politicosocioeconomic (feel free to use that one!) system.  For all of the talk of the Bush years or the post-Carter years as being hyper-capitalistic or given over to “free market fundamentalism”, the truth is that we oscillate between social democracy and democratic capitalism, the only difference being how much deregulation should be permitted in an essentially closed system.  You cannot have a free market when the fundamental component of markets, i.e. money, is determined by a set of semi-private, state-appointed, politically sensitive academics—you know, central banks.  When one includes not merely government stabilizers like unemployment benefits, but social programs in pursuit of a War on Poverty or Universal Healthcare or Social Security, then the economy is something, but not hyper-capitalist, even if capital gains taxes are periodically lowered.

What, you may ask, does this have to do with Mish and the Fed?  Well, Mish, in reaction to yesterday’s Fed statement, is arguing that the Fed is lying when it says the economy is not “deteriorating significantly” and that the Fed will respond to this deterioration by engaging in more inflationary measures.  Mish points to a number of indicators and index numbers to show that the economy is not merely “sluggish”, but deteriorating significantly.  Unfortunately, I am afraid I cannot offer contrary examples of indicators and indices because I am constitutionally ill-disposed to paying them too much mind, and as we discussed above, there is good reason not to be too dependent on them.  I would argue, however, that the recent “economic data” has been mixed, in general, and that the equity, commodity, currency, property, labor, and bond markets have shown either stabilization or improvement in recent months.  Certainly, gold continues to hang over the markets like a storm cloud over Noah’s ark, threatening to wash away all the unheeding evildoers, but as I have argued in recent weeks, the deluge is not yet upon us, conditions are likely to improve dramatically (if temporarily), and therefore, the Fed is unlikely to engage in even more quantitative easing.

Whether it does or not, I think the Fed has already done plenty to set the wheels of the next months and years in motion.  I stand by the predictions I have made regardless of whether or not the Fed launches QEII.  Gold bugs, a term I confess to throwing about with too much abandon, know that central banks and politicians and the hoi polloi and the intelligentsia love cheap money and in a time of economic trouble are bound to let loose the dogs of inflation, but one should be mindful as well that the Fed does not always open the taps.  The Fed, after all, brought the crisis to a head when it raised interest rates to cool down an overheating economy.  As Cooper has shown, the Fed held rates too low for too long and then raised them too high and/or too long.  (Howard Katz has pointed to Fed action as the proximate cause of crashing markets, as well.)  Now, the Fed undoubtedly (or so it seems to me) has pumped too much liquidity into the system and it may well do so again, but gold bugs should not assume that this is inevitable.  If (as it seems to me) the economy is about to blow through “recovery” on its way to “overheating” again, we may see the Fed raise rates dramatically in a year or two.  And, gold might suffer in the meantime as things briefly appear to return back to the Old Normal.

As Marc Faber has argued repeatedly, gold bugs should be cautious about being too dogmatic in their analysis of economic conditions.

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1 comment so far

  1. Dow 13000? « Herodotus Now on

    […] economy have stabilized.  Whether or not one believes that things have stabilized depends on which stats you look at, but I believe that the stability of asset prices around the world over the course of […]


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