Posts Tagged ‘congress’

Germany’s head central banker calls it the work of the devil. Last year, Jens Weidmann, Germany’s answer to Mervyn King, told a story from ‘Faust’. A king is running out of money, and the devil disguised as fool persuades him to solve his problem by printing new money. The result was hyperinflation. And that, says Mr Weidmann, is why QE is like the work of the devil.

It is just that QE is not really money printing at all. When the Bank of England buys government bonds it is assumed that it will sell the bonds at a future date.  So if QE looks as though it is leading to inflation, the effects can be reversed.

That’s the theory.

The reality is that that QE doesn’t seem to be doing an awful lot. Sure it may have stopped the recession from becoming  worse, but given the sheer size of this measure – £375 billion in the UK so far – it seems remarkable how low inflation is, and how tiny growth is.

The snag is that debt is the key to the banking system we have these days.  When we borrow money from a bank, we spend it and the recipient of our money pays it into a bank. So when a bank lends money, the money it lends reverberates around the economy. In this way, by their lending, banks create money.

But if we all suddenly decide to borrow less, or if banks decide they can’t afford to lend so much, the broad money supply may well contract faster than an anaconda on speed. QE has had the effect of mitigating this contraction. But it certainly has not had the effect of creating massive growth in the broad money supply.

Perhaps then it is time to really engage in money printing and hand the resulting money out across the land. Milton Friedman pretty much suggested such an idea once. He said that in times of a depression if all else fails, why not scatter money from a helicopter. Before he was chairman of the Fed, Ben Bernanke once said he thought Friedman may have been right.

But that’s where the devil comes in: wouldn’t money printing in this way just create inflation?

For that matter, this whole idea of running a large government deficit is also seen as pretty much akin to devil worship – by some.

Well, maybe. But explain why it is that in times of war – World Wars 1 and 2 for example – governments suddenly found that they could print money to fund the war effort, and could run-up huge deficits. And why is it that the post war periods were not followed by inflation, rather than economic boom, which was often the result. Sure, Germany had hyperinflation, but that was down to the Treaty of Versailles. The UK limped along in the 1920s, but that was largely because adherence to a gold standard removed the Bank of England’s ability to create money. The argument continues to say that periods in history when governments ran surpluses were invariably followed by economic depression. See: conspiracy theories, free lunches, and the theory that banks are destroying wealth .

Some go further – they say the insistence that governments run prudent fiscal policy is a conspiracy, forced upon us by banks who are trying to protect their nice little way of making money. Is the conspiracy theory right? Probably not. But the point is that there is an alternative idea to the established view. The idea suggests that instead of the money supply growing via debt created by banks, the government boosts the money supply by creating new money, and banks’ ability to create credit is then curtailed by legalisation.

The argument may or may not be right. But we may be getting an opportunity to test the theory soon.

As US politicians refuse to compromise, and Republicans and Democrats blame each other for the US’s woes, Obama may have come up with a solution.

Under US law the US government cannot print money – that job is entrusted to The Fed. Except, thanks to legislation from 12 years ago, the government is allowed to create platinum coins. The legislation was designed simply to enable the US government to create commemorative coins.

So why not make a one trillion dollar platinum coin, deposit it with the Fed, and then withdraw money against it, thereby abolishing the US government’s need to have approval from Congress before raising its fiscal debt? Friedman and Bernanke will get their money drop, and the conspiracy theorists will have their chance to put their theories to the test.

But such a measure, unlike QE, can’t be reversed. Critics say such a move really would create inflation.

Paul Krugman, the Nobel Laureate who pens a highly influential blog for the ‘New York Times’, has suggested he is in favour of the idea. But it seems he really sees this as kind of a warning shot. He doesn’t really want to see a one trillion dollar coin; rather he reckons the threat of taking such an action will be enough to ensure that the Republicans compromise with Obama.

Perhaps what we can say is that that we are seeing a very interesting development in the story of our times.

©2012 Investment and Business News.

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It all boils down to checks and balances.

Obama has won himself another four years in office, but Congress is still split.

If you are pro Republican, that’s a relief; at least President Obama can be held in check. If you are a Democrat that’s a blow, a major blow. Will Congress make Mr Obama a toothless President?

If you are a credit ratings agency, right now you may be looking forward to a spot in the limelight as you prepare to downgrade the US’s credit rating.

But before the why and wherefores are considered, let’s get rid of some nonsense.

Critics of Obama say taxes need to rise. They say his victory in the election is a disaster for the US economy because it means higher taxes. But answer this question: if the problem with the US is that taxes are too high, how is it that by some measures US taxes are close to their lowest level since the end of World War 2?

In 1965 the US government tax receipts accounted for 24.7 per cent of GDP. Today they account for 24.8 per cent of GDP. Across the developed world over the same time period, tax receipts rose from an average of 25 to 34 per cent of GDP. Across the industrial world, only in Chile and Mexico are tax receipts to GDP lower.

There are lots of reasons why the economy in the US has not performed well in recent years, but please don’t say it was because taxes were too high.

The snag is that the US constitution has been designed, quite deliberately, to reign in the power of the President. Major legalisation has to go through Congress. And Congress itself is divided into Senate (where Democrats have a small minority) and the House of Representatives, where Republicans have a larger majority.

There is actually another tier too, The US Supreme Court. Currently, five judges in this court were appointed by Republican Presidents, and four by Democrat Presidents.

This system of checks and balances has largely made Mr Obama, well alas the spam checker will not allow the appropriate word, but it begins with an imp, followed by an ot, and ends with an ent.

This is especially a problem when it comes to the fiscal ceiling. When US debt rises above a certain level, the US Congress has to give its assent. If it refuses, the US has to stop borrowing. 12 months ago, the US approached this fiscal ceiling, and Congress went down to the wire in giving its approval. During this period of uncertainly, Standard and Poor’s downgraded the US credit rating.

On 1 January, the fiscal ceiling is not up for renewal, but the compromise agreed by Congress is.  As things stand taxes will rise, spending will fall, and the US may well fall into recession as a result.

The question is: how will Republicans in Congress react? Will they look at the electoral college, see that Obama has won by a pretty convincing margin and then conclude they have to obey the will of the people and assent to Obama’s plans? Or will they look at the popular vote, note that in terms of votes cast across the US Obama and Romney were pretty much neck and neck, and say that means it’s their duty to thwart Obama at every opportunity?

Obama’s error was not to take advantage of the Democrats’ majority during the first half of his first term in office. He can only hope that in two years’ time, Democrats will gain control of the House of Representatives again.

As for the Supreme Court, no less than four of the nine judges are over 70, split 50/50 between Republican and Democrat appointees. Some of these judges will inevitably step down and Obama may have the opportunity to change the balance of power in the Supreme Court.

In the long run, however, demographics are at work. In 2000 18 per cent of US citizens under 18 were so-called Hispanics. In 2010 that number was 23 per cent. Hispanic populations are especially significant in Texas (up to now a Republican stronghold) and Florida (a key state in this election).

Ronald Regan once said all Hispanics are Republicans, but they just don’t know it. Certainly under the former B movie actor, a sizeable minority of Hispanic voters put their X in the Republican box. However, the rise of the Tea Party has put many of these former Republican voters off.

Looking forward, it seems that demographics mean that we will either see many more Democrat Presidents, or the Republicans will be forced to move to the left, or perhaps (but unlikely) we will see the emergence of a third political party.

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here