Merkel, like the conservatives in the US, is wrong.  This is not a recession like other recessions, which means that inflation is NOT a priority problem.  Inflation belongs to that set of problems which Keynes dismissed with his famous quip, "in the long run, we're all dead."

At the end of the day, any sound economic analysis of the current situation recognizes that the problem needs to be solved by a fairly radical redistribution of wealth in order to both prevent deprivation as well as generate private spending, investment and economic activity within the market framework in which capitalist society is organized. Self regulating markets cannot redistribute wealth so political authorities must do it, and there are really only three tools with which to work:

1. current redistribution:  take from the haves and give to the have-nots through progressive taxation.

2. future redistribution: take from the future and give to the present through borrowing.

3. savings redistribution: take from savers and give to spenders through monetary expansion.

It is very likely that there are diminishing returns to following any one of the three policy options, so it's highly probable that social welfare is optimized by using a combination of all three. Given the research by Ken Rogoff on the 18 major recessions since WWII that were brought about by financial system crises  (here:http://www.economics.harvard.edu/files/faculty/51_Aftermath.pdf; sorry I'm html challenged), the average real public debt increase by national economies three years after the crisis became manifest was was 86% of the public debt at the time the crisis became known.  In the case of the US, if it was to be average, that would require in increase in the total national debt of about $9 trillion dollars (not including temporary, which make up almost all of the $13 trillion that the Fed has extended.)  The total amount of debt increased, between monetary expansion and new US debt since the crisis began, excluding committments, most of which won't be realized (knock on wood), is about $5 trillion at most so far.  

Why is the debt and monetary expansion required? Because of the drastic contraction in private debt public debt needs to take over the spending power of private individuals and businesses -- it's  a de facto nationalization of massive parts of the economy and the implementation authority for doing it is the largely central bank  Private money and spending power has dissappeared, so government spending power, through issuance of debt and new money needs to take up the slack by commanding people to make things and service others that markets are no longer able to do.  It is unlikely that the government issuance of debt and new money can ever replace the total private spending power in existence before the crisis became manifest, so there is, therefore, little theoretical reason to expect inflation to EVER have to occur.  Inflation will only happen if monetary expansion (public or private) continues too much AFTER market mechanisms for allocating credit, goods, and services have recovered and the private economy is growing again.  

So, fuck inflation. It's not the danger right now.  Deprivation, particluarly for the most vulnerable members of advanced industrialized societies, is.  Go Bernanke and to hell with Merkel.

Central banks will face a Scylla and Charybdis flation challenge for years  An Edward Harrison guest post on Naked Capitalism

Edward Harrison sees both inflationary and deflationary forces at work over the next several years, and he concludes:

This will present policy makers with a problem as the reflation trade comes good, and the resulting policy responses will have serious implications on the medium term outlook for the economy and asset markets.

Deflation:

He sees the current crisis as a continuation of an asset bubble begun in 1997 under Greenspan.  The collapse of this bubble has resulted in deflation and, in his view, depression.  What results is 'the D process,' deleveraging, deflation and depression.  Companies go from being concerned with profits to being concerned with reducing debt.  This limits the effectiveness of monetary policy.

In sum, the psychology after a major bubble is very different than the psychology before its collapse.  The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some (time) to come.

Inflationary factors:

Edward Harrison sees two major inflationary factors: commodity prices and money supply.

The Federal Reserve and other central banks have been pumping a lot of money into the financial system in an attempt to add reserves to the system and to take on the intermediation role the wider banking system normally serves.  Nevertheless, this money is not being lent out and excess reserves are piling up at the Federal Reserve.  Last April, there were only $1.8 billion in excess reserves i.e. reserves against which loans were not being made. According to figures just released by the Fed on May 28th, this April that figure has soared to $824.4 billion, a surge of 447 times in one year. If you want to know what is wrong with the American economy, you should start here.

-Skip-

But, what happens when the economy returns to an environment in which those excess reserves start to be lent out?  Inflation.  And this is an inflation that will not be so easy to control because the Federal Reserve has embarked on a policy of `qualitative easing' by buying up non-treasury assets, transforming its balance sheet from one dominated by treasury assets to one in which Treasury assets are in the minority.  So, as the Fed has intervened and bloated its balance sheet, an increasing amount of the assets it has with which to withdraw the excess liquidity in the system is hard to sell.

So, you have a huge amount of excess reserves, hard to sell assets on the Fed's balance sheet.  Add in the fact that the Federal Reserve is going to be loathe to choke off an incipient recovery and you have the makings of inflation when recovery takes hold.

Moreover, there is a rise in commodity prices which is adding inflation to the pipeline.  Much of the recent decrease in headline inflation numbers is due to the collapse in commodity prices.  But, Copper is near a seven-month high. Oil is near a seven-month high.  And all of the agricultural and industrial commodities are taking off again.  As China ramps up its economic stimulus, the recent increases in the ISM manufacturing data in the U.S. and elsewhere point to an increasing demand for industrial commodities, and this is inflationary.

In sum, any pickup in the economy is going to be met by a host of inflationary forces.  This is one reason that bond yields have been increasing and the spread between the two-year and 10-year U.S. government bond is near a record.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

... a bout of extreme or even hyperinflation, as the US collapsed from reserve currency status, a period of prolonged stagnation, as the UK after WWI as it was struggling to return to pre-war gold parity, or what I have called a "Brawny Recovery" ... substantial stimulus that focuses heavily on spending that closes our structural current account deficit.

However, it is important to not fall into a lazy mechanical model of inflation and monetary policy.

Monetary policy is not just how many reserves are injected or drained from the private sector and on what terms. Banks create money, so bank regulation is also monetary policy. Open lending of reserves to commercial banks at a low, stable cash rate, combined with strict regulation of the lending activities that banks are allowed to engage in, can be a "looser" monetary policy than a policy of generating fewer reserves, but placing no genuine restraint on what banks can do in terms of creating new forms of liquidity.

In the end, Central Banks cannot restrain the creation of money under the terms that they permit, though they do, of course, have much wider powers than have been used in recent times to dictate the terms under which money is created.

And that is precisely the way to view monetary policy over the past thirty years. It is not whether it is "tighter" or "looser" monetary policy that is the principle shift from the collapse of Bretton Woods to today ... it is the shift in the channels into which money is created.

Since the 1970's, Central Banks have increasingly raised interest rates whenever there is a risk of productive activity getting strong enough to allow wage laborers to gain substantial bargaining power across the board. So with regard to the activity of the productive sector, monetary policy has been "biased to be tight whenever it matters".

By contrast, in the ongoing eliminating of restrictions on creating money to provide liquidity directly to the Finance Sector, which is to say in response to complaints from the Finance Sector that they require more liquidity ... the Finance Sector has been faced with a monetary policy that has been "biased to be loose whenever it matters".

Central Bank monetary policies have by no means just been "creating" liquidity which "happened" to flow into financial assets rather than into the income-expenditure cycle ... they have, rather, been proceeding to encourage the creation of money by commercial banks in service of inflation of financial assets, at the same time as they discourage emergence of a full employment productive sector.


Utsukushikereba sore de ii

this is a defense of the independence of the Central Banks - at least the ECB - against the massive pressure from bankers, pundits and others who have said that salvation can only come from massive monetary injection into the financial system.

Well, right but ... is she trying to do it through the other side? Acting on money velocity?

Btw, looking at bonds and currencies charts these days it looks pretty clear that the delationistas and the pure monetarists that bandwagoned with them are loosing ground.

Vencit omnia veritas.

China's Yu Tells U.S. Not to Be Complacent About Debt

June 2 (Bloomberg) -- China's former central bank adviser Yu Yongding will meet Treasury Secretary Timothy Geithner today and tell him the U.S. shouldn't be complacent about China continuing to buy Treasuries.

"I wish to tell the U.S. government: `Don't be complacent and think there isn't any alternative for China to buy your bills and bonds', Yu said in an interview yesterday. "The euro is an alternative. And there are lots of raw materials we can still buy."

Federal Reserve puzzled by US yield curve steepening

WASHINGTON, May 31 (Reuters) - The Federal Reserve is studying significant moves in the U.S. government bond market last week that could have big implications for the central bank's strategy to combat the country's recession.

But the Fed is not really sure what is driving the sharp rise in long-dated bond yields, and especially a widening gap between short and long term yields.

Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit? If so, there might be less need for the Fed to expand the money supply by buying more U.S. Treasuries.

Or does the steepening yield curve mean investors are worried about the deterioration in the U.S. fiscal outlook, or the potential for a collapse in the U.S. dollar as the Fed floods the world with newly minted currency as part of its quantitative easing program. This might be an argument to augment to step up asset purchases.

Another possibility is that China, the largest foreign holder of U.S. Treasury debt, has decided to refocus its portfolio by leaning more heavily on shorter-term maturities.

Inflation, or dollar devaluation, or both?

In the long run, we're all dead. John Maynard Keynes

Why the Chinese Laughed at Geithner   by Paul Craig Roberts

Federal Reserve Chairman  Ben Bernanke thinks he can hold down US long-term interest rates by purchasing mortgage bonds and US Treasuries.  Sixty years ago the Federal Reserve understood that this was an impossible feat.  After an acrimonious public dispute with the US Treasury, in    1951 the Federal Reserve forced an "Accord" on the government that eliminated the Fed's obligation to monetize Treasury debt in order to hold down long term interest rates.

President Truman and Treasury Secretary John Snyder wanted to protect World War II bond purchasers by preventing any rise in interest rates, which would mean a decline in the price of the bonds.  The Fed understood that monetizing the debt to hold down interest rates meant loss of control over the money supply.  The policy of suppressing interest rates could only work until the financial markets anticipated rising inflation and bid down the bond prices.  If the Fed responded by buying more Treasuries, the money supply and inflation would rise faster.

Since Fed Chairman Bernanke announced his plan to purchase $1 trillion in mortgage and Treasury bonds in order to help the housing market with low interest rates, interest rates have risen.  When will the Fed remember that printing money does not lower long-term interest rates?

According to Bloomberg (June 3), Bank of America strategists are recommending that investors buy Fannie Mae bonds because the rise in interest rates means the Fed will ramp up its purchases in order to prevent rising interest rates from adversely impacting the struggling housing market.  When will financial gurus remember that printing money does not lower interest rates?

Treasury Secretary Geithner is another economic incompetent.  He told China that he stood for a "strong dollar," but that China should let its currency appreciate relative to the dollar, which, of course, would mean a weaker dollar.  He simultaneously told China that their investments in US Treasury bonds were safe.

His Chinese university audience, being economically literate, laughed at Geithner.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

During a speech at the London School of Economics in january Bernanke was saying:

Mr. Bernanke said the Fed had already done a great deal to help stimulate the economy -- like lowering its benchmark interest rate to virtually zero in December -- but that it still has "powerful tools" at its disposal.

He argued that the Fed's approach is different from the quantitative easing policy used by the Bank of Japan from 2001 to 2006 and should be described as credit easing. Even though both methods involve the expansion of the central bank's balance sheet, the Fed's focus is on reducing credit spreads that are much wider in the United States now than was the case in Japan.

In his remarks, Mr. Bernanke also sought to calm concerns that the Fed's actions will fan inflation by effectively printing money. Risks of inflation remain low in the near term, he said but added that once the credit markets begin to recover the Fed will have to unwind its lending programs.

"*To some extent, this unwinding will happen automatically," he said, and short-term assets can just be allowed to "run off." Still, the Fed might hold on to some of the longer-term assets for a while, which could slow down efforts to shrink its balance sheet.

and yesterday the Economist was claiming that "The Federal Reserve weighs plans to unwind its unconventional stimulus":

A firefigher's first rule of survival is "know your way out". The same can be said of financial firefighting. Though it has no intention of exiting soon, the Federal Reserve is planning its path out from the extraordinary measures it has taken to free credit markets and boost demand.

Free at last! Free at last! Thank God Almighty, we are free at last! (Martin Luther King)

Also, J, given that the Fed moves have pushed the dollar down against the euro and made American exports more attractive, you don't suppose there might be some politics behind this from the world's largest exporter, do you?  While she went after all the central banks, she certainly seemed to go after the Fed more.

Another point I'd make, in defense of the ECB, is that suddenly now you seem to believe that Trichet has bowed to political pressure, when for years you've portrayed him as a responsible central banker, much more so than Bernanke and King.  So why the new belief that Trichet is suddenly an idiot and should bow to political pressure from Merkel?

It strikes me as a little confused.  If Trichet does something you or Angela Merkel like, he's awesome.  If not, he must clearly be bowing to political pressure rather than simply doing his job as the evidence suggests to him he should.

Be nice to America. Or we'll bring democracy to your country.