We are going with Fischer on this one!

Key News

  • The U.S. economy lost 598,000 jobs in January, as the jobless rate rose to 7.6%. Total job losses since the recession started in December 2007 to 3.6 million.

Quotable

"You can observe a lot by watching.”

                               Yogi Berra

FX Trading – We are going with Fischer on this one!
A was chatting with a friend of mine who works at a firm in Chicago; it went something like this:

Fiend: A lot off rhetoric out of Washington last night
Me: And your point is…LOL
Friend: Trying to coax the market into a sense of security
Me: Sure…that’ll do it
Friend: For 120-minutes

Point being, all the money the Washington gang has thrown at the economy already, one could say the job market is telling us and them it ain’t working.  And may be suggesting that a new tack might be in order; but it seems more of what isn’t working is headed our way.

So, despite the rally in stocks this morning, it is most likely another mini false dawn, about 120-minutes in the scheme of things as my friend so aptly sums up.

Anybody else get the feeling our government is heading too quickly down the wrong policy road?

Below comes from an article I wrote for another publication to be published tomorrow, but you get a sneak peak at the excerpt, luck you I am sure you are saying to yourself…LOL.  Keep in mind, I am not an economist, nor do I ever wish to be confused for such a person–my higher math skills are a bit lacking and I tend to live in the real world.  Anyway, here is my summation on the debate where more stimuli will really help.  It boils down to whether you believe Irving Fischer or Milton Friedman was right. 

…Let me explain the term monetary velocity, because it is crucially important to this battle for the hearts and minds of economically-inclined everywhere, and for real people who are very concerned about what’s playing out.

Monetary velocity effectively means how fast money is circulated in the economy–the speed in which it is spent.  And it is a key measure in an economic equation with important moving parts that determine growth and pricing.  Now stay with me, this is important and I think help you understand this very important debate once you get this simple equation in your head:

M x V = P x O
M = Money Supply
V= Velocity
P = Price Level
O= Economic Output

This simple equation covers it all in this battle.  Milton Friedman (and Ben Bernanke and those in control of the present US economic policy believe that if the “M” in this equation is lifted, it will impact prices (reduce the deflationary scare) and output (economic growth) accordingly.

But here is the rub: When debt levels reach such huge levels, people get scared and save and hoard and use money to pay down debt.  They don’t take on more debt or run out and do more spending just because the money supply has been increased by the government.  In fact, more money pumped into the system only adds to the total debt in the economy and therefore prolongs the downturn.

The viable policy is to accept the fact that “V” (monetary velocity) shrinks dramatically at times like these–thus we have the big dip in “O” (output) and “P” (prices); this IS the way the market cleanses the system by paying down the debt and rebuilds reserves (by increased consumer and institutional savings) to provide the eventual pool of capital for fresh growth once the debt in the system is removed.

And once the debt is removed, monetary velocity “V” increases to more normal levels; therefore tinkering with money supply isn’t necessary.

Thus, Black Swan sides with Irving Fischer on this one despite that we are huge Milton Friedman fans on so many other issues.  If you want to read his landmark paper, “The Debt-Deflation Theory of Great Depressions,” you can find it here.  Very enlightening in that it shows we have seen this all before and governments are still wondering how to appropriately respond.  It is yet another reason why economics has absolutely no right to include the word “science” anywhere within the same paragraph. 

The dollar is getting a bit spanked today, but overall acting will in light of the dismal job news.  We still believe the global economy is in for a sustained period of risk aversion, far longer than market cheerleaders and dollar bears now expect.  If we are right here, we think the probabilities still have to favor the dollar trending higher.

But, given that we trade our own money and give much back to Mr. Market at times, we are painfully aware that anything we do and talk about here has nothing to do with science.  So stay tuned.

Have a great weekend.

6 comments

  1. Pride

    It’s Stanley Fischer, not Irving Fischer we should be heeding!!!

    What a great article Jack the Pipper, and very eloquently put. Apologies in advance for such a long and rambling post. Please be assured of my intentions, I read and enjoy a lot of your Blog postings and this is not a critique, argument or opinion on your Blog, just simply my ‘conscious stream of thought’. You are right in that monetary policy, does not seem to be succeeding in having what is usually a very subtle, but very powerful effect on steering economic growth (Output) in the right direction.

    But the reason modern economics follows Milton Friedman and puts so much emphasis on the left hand side of the equation is that the effects of monetary policy can almost be instantaneous and can usually gets straight to the problem, all this without most of the adverse effects on the real economy that would or does occur from negative adjustments on the right hand side.

    “The viable policy is to accept the fact that “V” (monetary velocity) shrinks dramatically at times like these–thus we have the big dip in “O” (output) and “P” (prices)”

    M x V = P x O
    M = Money Supply
    V= Velocity
    P = Price Level
    O= Economic Output

    “P” in this equation encapsulates wages and prices of all goods and services in the economy. Stanley Fischer of MIT along with John Taylor of Columbia (now at Stanford I think) showed that the adjustment of “P” can be incredibly slow, even under the theoretical notion of rational expectations. This means prices and wages stay way too high for far too long for the given level of “M” and “V” in the economy.

    That only leaves reducing “O” to balance the equation. This is by far the most important part of the equation. Why? Because it is the physical measure of how we are doing as a country. So its ok if O declines maybe? How does it decline? By reducing employment; by businesses going bust; by values of assets declining; by individual, commercial and national wealth decreasing. Until eventually down to the level until “O” has reduced far enough to make the equation balance; or in other words America has gone economically backwards in time far enough for the equation to be in equilibrium again! Be warned this can set off a viscious reinforcing circle, i.e. reducing “O” reduces “V” and vice versa, both these variables can act as cause and effect at the same time. (All economics can be reduced to a single word: Expectations)

    Even with this there is nothing guaranteed or inevitable about a recovery! At the turn of the century, Argentina was the number 1 economy in the world, its people were the richest and had everything going for them. Complacency got them no where. All the economic indicators signalled a steady forward march of inevitable economic growth and economic domination: generously endowed with natural resources; perfect climate and geography for its huge agriculture industry; a growing and successful industrial base; good infrastructure including modern cities, transport, ports, railways etc.; excellent trading position; and a young educated, and motivated European population. Somehow they threw it away.

    Getting back to the original problem and examining Milton Friedman’s famous monetary model of the economy. The US government could take the easy route and abdicate itself of its responsibilities to the country and sit back and let the fiscal economy (right hand side of equation) work itself out and adjust to match the monetary economy (LHS). This might bring the US economy back into equilibrium steady state growth. i.e. the equation eventually balances out but at much reduced output. [Worst case scenario it leads the US into a steady state decline and the US meets Russia and China on the way down, remote but possible]. Well who wants to wait that long to find out if doing nothing will make everything all right again? It is a lot of waiting; a lot of hoping; and absolutely no guarantees; and an unbelievable amount of real pain, real people will have to endure and survive somehow on their own, without help from their elected government. And what is the optimistic prognosis; maybe… if in 5 yrs time the US is back to where it was 5 yrs ago, and the economy is growing again… that’s OK? ! ?

    This same debate occurred around the time of the last Depression. Those who thought (wrongly) they might lose out from an active government, argued vehemently against any intervention from the government. In the long run they said, everything would work itself out. They were attacking that other great giant of 20th century economics, John Maynard Keynes, who had created the famous fiscal model of the economy on which the ‘New Deal’ was grounded on. He was the quintessential pragmatist and believed strongly that macroeconomic policy should be based on how it effects the welfare of the common man (or woman). It turned out though, he agreed with his critics completely, and he replied with the most famous quotation in economics.

    “Yes,” he said, “but in the long run we are all dead.”

    Reply
  2. Pride

    It’s Stanley Fischer, not Irving Fischer we should be heeding!!!

    What a great article Jack the Pipper, and very eloquently put. Apologies in advance for such a long and rambling post. Please be assured of my intentions, I read and enjoy a lot of your Blog postings and this is not a critique, argument or opinion on your Blog, just simply my ‘conscious stream of thought’. You are right in that monetary policy, does not seem to be succeeding in having what is usually a very subtle, but very powerful effect on steering economic growth (Output) in the right direction.

    But the reason modern economics follows Milton Friedman and puts so much emphasis on the left hand side of the equation is that the effects of monetary policy can almost be instantaneous and can usually gets straight to the problem, all this without most of the adverse effects on the real economy that would or does occur from negative adjustments on the right hand side.

    “The viable policy is to accept the fact that “V” (monetary velocity) shrinks dramatically at times like these–thus we have the big dip in “O” (output) and “P” (prices)”

    M x V = P x O
    M = Money Supply
    V= Velocity
    P = Price Level
    O= Economic Output

    “P” in this equation encapsulates wages and prices of all goods and services in the economy. Stanley Fischer of MIT along with John Taylor of Columbia (now at Stanford I think) showed that the adjustment of “P” can be incredibly slow, even under the theoretical notion of rational expectations. This means prices and wages stay way too high for far too long for the given level of “M” and “V” in the economy.

    That only leaves reducing “O” to balance the equation. This is by far the most important part of the equation. Why? Because it is the physical measure of how we are doing as a country. So its ok if O declines maybe? How does it decline? By reducing employment; by businesses going bust; by values of assets declining; by individual, commercial and national wealth decreasing. Until eventually down to the level until “O” has reduced far enough to make the equation balance; or in other words America has gone economically backwards in time far enough for the equation to be in equilibrium again! Be warned this can set off a viscious reinforcing circle, i.e. reducing “O” reduces “V” and vice versa, both these variables can act as cause and effect at the same time. (All economics can be reduced to a single word: Expectations)

    Even with this there is nothing guaranteed or inevitable about a recovery! At the turn of the century, Argentina was the number 1 economy in the world, its people were the richest and had everything going for them. Complacency got them no where. All the economic indicators signalled a steady forward march of inevitable economic growth and economic domination: generously endowed with natural resources; perfect climate and geography for its huge agriculture industry; a growing and successful industrial base; good infrastructure including modern cities, transport, ports, railways etc.; excellent trading position; and a young educated, and motivated European population. Somehow they threw it away.

    Getting back to the original problem and examining Milton Friedman’s famous monetary model of the economy. The US government could take the easy route and abdicate itself of its responsibilities to the country and sit back and let the fiscal economy (right hand side of equation) work itself out and adjust to match the monetary economy (LHS). This might bring the US economy back into equilibrium steady state growth. i.e. the equation eventually balances out but at much reduced output. [Worst case scenario it leads the US into a steady state decline and the US meets Russia and China on the way down, remote but possible]. Well who wants to wait that long to find out if doing nothing will make everything all right again? It is a lot of waiting; a lot of hoping; and absolutely no guarantees; and an unbelievable amount of real pain, real people will have to endure and survive somehow on their own, without help from their elected government. And what is the optimistic prognosis; maybe… if in 5 yrs time the US is back to where it was 5 yrs ago, and the economy is growing again… that’s OK? ! ?

    This same debate occurred around the time of the last Depression. Those who thought (wrongly) they might lose out from an active government, argued vehemently against any intervention from the government. In the long run they said, everything would work itself out. They were attacking that other great giant of 20th century economics, John Maynard Keynes, who had created the famous fiscal model of the economy on which the ‘New Deal’ was grounded on. He was the quintessential pragmatist and believed strongly that macroeconomic policy should be based on how it effects the welfare of the common man (or woman). It turned out though, he agreed with his critics completely, and he replied with the most famous quotation in economics.

    “Yes,” he said, “but in the long run we are all dead.”

    Reply
  3. PipViper

    Thanks for the detailed post, but I think your analysis is off a bit. Firstly, The Govt hasn’t thrown ANY money at the ECONOMY. The money was thrown at the BANKS (and a couple bucks to handpicked companies, i.e. GM, Chrysler). This was done to help alleviate a continual tightening of credit conditions. So any direct correlation with jobs is sketchy. This upcoming stimulus package due to be passed by the senate this weekend will address the velocity of money (V) situation. By pumping money into the system there will be an initial, albeit manufactured, increase in V. The hope is that it helps to stimulate real V, eventually stimulating confidence, thereby getting individuals and business to increase their V when they feel there future and jobs are safe once again. In sum, raising their EXPECTATIONS. This is the plan, don’t know if it will be a success.

    Reply
  4. PipViper

    Thanks for the detailed post, but I think your analysis is off a bit. Firstly, The Govt hasn’t thrown ANY money at the ECONOMY. The money was thrown at the BANKS (and a couple bucks to handpicked companies, i.e. GM, Chrysler). This was done to help alleviate a continual tightening of credit conditions. So any direct correlation with jobs is sketchy. This upcoming stimulus package due to be passed by the senate this weekend will address the velocity of money (V) situation. By pumping money into the system there will be an initial, albeit manufactured, increase in V. The hope is that it helps to stimulate real V, eventually stimulating confidence, thereby getting individuals and business to increase their V when they feel there future and jobs are safe once again. In sum, raising their EXPECTATIONS. This is the plan, don’t know if it will be a success.

    Reply
  5. Pride

    Sorry about the over detailed and long and rambling post (I didn’t realize the comment box doesn’t allow you to word process the post). Totally agree that the key is changing Expectations, lets hope it not too little too late to turn this thing around. – I’ll keep it short from now on;)

    Reply
  6. Pride

    Sorry about the over detailed and long and rambling post (I didn’t realize the comment box doesn’t allow you to word process the post). Totally agree that the key is changing Expectations, lets hope it not too little too late to turn this thing around. – I’ll keep it short from now on;)

    Reply

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