Munger disagrees with my optimistic take on the Fed's profit:
Here's the thing: if inflation cranks up, the Fed is going to have to unload a buttload of debt, really fast. The only way to sell that much debt, and take excess cash out of the economy, is to sell at fire sale prices.
So, if there is inflation, the Fed is going to take truly ginormous capital losses on the debt it will have to sell. But this is exactly Bernanke's plan, the one he is so sure will work to prevent inflation. Big Ben's talk at the AEA meetings made much of this policy. But who in the world is going to buy CDOs in this market?
The lagniappe: Lots of the CDOs are based on fixed interest rate mortgages. If there is inflation, the capital value of those gets hammered. All the rest are based on ARMs of some kind. And for those the PAYMENTS skyrocket with nominal interest rates, and defaults go up, and AGAIN the CDOs' capital value takes it right up the ol' gazoch, with a red hot poker.
This is not really a good policy.
All of this is true... if inflation cranks up in the short-run. What do the markets think about inflation? Here is the most recent TIPS spread (the difference between nominal T-bills and inflation-protected T-bills, which represents the market's expectations about inflation):
This indicates that the market does not anticipate inflation to "crank up" any time soon. In fact, it means that we are at a much greater risk of deflation than inflation. Which means that the Fed policy is actually a very good policy, given the circumstances.
Of course, Munger is free to disagree with the markets if he pleases, but a libertarian should do so at his own risk.
As Krugman says, the danger that we'll end up in a Japan-style situation is much greater than the danger that we have rampant inflation in the short-run. In the medium-run, sure. But by then the Fed will have had plenty of time to off-load its risky assets at acceptable prices.
2 comments:
Dude! I was with you, until you quoted Krugman.
P-Kroog deserved his Nobel Prize. But he knows no more about macro than I do. He is a total shill for the Obamadmin. And saying we should fear deflation is an excellent justification for our current policies.
Nonetheless, your OTHER points are well taken.
I would point out that Ben Bernanke really did say that he could control inflation. I was there, at the AEA meetings. He said. He is wrong about that.
Still, YOU may be right that he won't need to. That's a different point. A good point, but a different point.
Well, Bernanke HAS to say that he can control inflation in public, even if he's worried in private. Right? Maybe he thinks: hey, if inflation turns upward, I do have to sell debt but I don't have to necessarily sell securities at fire-sale prices. I could also sell Treasuries, like I normally would, and hang onto the riskier assets until I don't have to lose money on them.
As for Krugman... maybe he's wrong about the similarities with Japan. Maybe not. I think it's worth entertaining the notion, however, especially since we've just spent a year with almost no inflation despite a monetary policy at the zero-bound and large amounts of quantitative easing. That looks like Japan. Whether it persists or not is another question, but just because Krugman is asking it doesn't mean it isn't worth asking.
- wkw
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