Left Coast Correspondent: BLM Rioters Pull Down Statue of Abolitionist Ulysses Grant, the General Who Ended Slavery

Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena learned in history class that Ulysses S. Grant commanded the armies that ended slavery in the American South.

The Emancipation Proclamation may have declared slavery over in America, but it was just a nonbinding piece of paper to the Confederacy until Grant made it the new reality.

Hence the toppling of his statue in San Francisco’s Golden Gate Park provides us another sample to refine IQ estimates within the militant woke crowd. So far we know for sure the average never exceeds the temperature on foggy San Francisco evenings.

https://thehill.com/homenews/state-watch/503685-protesters-tear-down-statues-of-union-general-ulysses-s-grant-national

The average might be even lower were it not for a handful of clever leftists who would point out Grant either bought or was given one slave in 1859 who he freed just a year or two later—right before the Civil War started. So surely owning one person for a year or two condemns Grant to the pantheon of evil bigots, right?

However former racist Klansmen like late West Virginia Senator Robert Byrd have been quickly forgiven for using the N-word repeatedly on national TV…

https://www.youtube.com/watch?v=PnO6ai0Ktro#t=01m13s

…or serving as a recruiter and Kleagle of the KKK because his friendly legislative efforts later “redeemed” him.

Same for “put y’all back in chains” Joe Biden who, despite having done nothing for minorities since telling radio personality Charlemagne da God “you ain’t black,” gets a pass and ardent support from the leftist movement to become the next POTUS.

https://www.youtube.com/watch?v=7xqodjauwT0

So if voting for and passing a few laws that channel more taxpayer money and help to minorities is enough to raise them to heralded do-gooder, is leading the armies that ended the institution of American slavery forever good enough to save a president's statue from destruction?

That would require more thinking than the self-righteous wokebots are capable of.

ps. The Grant statue story is hidden away on the San Francisco Chronicle's website, lost among at least 50 other tiny headlines at the very bottom of the homepage or the equivalent of a footnote on page B26.

Fed Coronavirus Policy Inflation Followup: CPI Falls for Third Consecutive Month

Click here to read the original Cautious Optimism Facebook post with comments

2 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff delivers his previously promised update on the Federal Reserve’s unprecedented efforts to provide liquidity to financial markets and its predicted effects on inflation.

The Bureau of Labor Services reported yesterday that consumer prices actually *fell* for the third straight month.

Read story here:

https://www.cnbc.com/2020/06/10/us-consumer-price-index-may-2020.html

Now the Economics Correspondent is open to criticisms that official CPI calculations use flawed methodologies to determine the cost of housing, and that including or excluding the officially “volatile food and energy sectors” can alter the results. Although for the record food prices have recently risen while energy prices have plummeted while economists predict prices may finally start to rise next month reflecting the recent rebound in oil markets.

However the Correspondent’s larger point is that according to some, none of this was supposed to happen. Inflation was supposed to be roaring by now simply because the Federal Reserve began historic and aggressive efforts to create new money to counter the coronavirus slump in mid-March.

The Fed has succeeded in creating new money, and a lot of it.

Since that historic week in March the monetary base has increased 47% from $3.53 trillion to $5.199 trillion.

https://fred.stlouisfed.org/series/BOGMBASEW

Bank reserves have increased 89% from $1.72 trillion to $3.25 trillion.

https://fred.stlouisfed.org/series/RESBALNSW

The money supply as measured by M1 (currency + demand deposits) has risen 24% from $4.14 trillion to $5.10 trillion.

https://fred.stlouisfed.org/series/M1

And the broader money supply measured by M2 has risen 14.5% from $15.8 trillion to $18.1 trillion.

https://fred.stlouisfed.org/series/M2

These numbers are all incredible and many are unprecedented, eclipsing even the alarming gains during the 2008 financial crisis. And all of this in a major recession with output falling.

So with far more money chasing even fewer goods and services, why isn’t inflation roaring? Shouldn't the U.S. be one step shy of Venezuela by now?

More money and falling output are indeed a formula for inflation, but they aren’t the only factors that influence prices. And as the Correspondent wrote in April, falling velocity might very likely offset inflationary factors—lower velocity being the product of millions losing their jobs, income, and spending power, and firms hoarding cash as a reserve instead of spending on huge investment projects during uncertain times.

Based on the scale of the Fed’s open market operations, the Economic Correspondent believed in March and April that the Board of Governors was already anticipating plummeting velocity in ensuing months, and so far they’ve been proven right. In fact, had the Fed not engaged in such aggressive monetary operations the U.S. could already be in a severe deflationary environment by now—severe meaning not a benign -0.5% or -1.0% annualized drop in prices but something much more rapid like -5% or even closer to -10% such as during the Great Depression.

And there has been one more, unmeasured factor subduing inflation: new money has spilled over into the stock market and created “asset inflation” which is not measured in the CPI index because consumers aren’t concerned with the price of the S&P 500 Index when paying their daily living expenses.

The Economic Correspondent has never been a big fan of the Federal Reserve or monopoly central banks in general, but so far on the inflation question the Fed has been right.

What inflationary prospects lie further down the road—in the medium or long terms—will be a speculative subject of discussion in a future column.

To learn more about the importance of the money supply, GDP, and velocity’s impact on consumer prices you can go back to Parts 4 and 5 of the Correspondent’s series on coronavirus monetary policy at:

http://www.cautiouseconomics.com/2020/04/monetary-policy-11.html

http://www.cautiouseconomics.com/2020/04/monetary-policy-12.html

Also for a primer on open market operations and the Fed's tools for controlling the money supply, as well as the Fed’s domestic and international rationales for its aggressive securities purchase programs beginning in mid-March, Parts 1-3 of the same series are at:

http://www.cautiouseconomics.com/2020/04/monetary-policy-08.html

http://www.cautiouseconomics.com/2020/04/monetary-policy-09.html

http://www.cautiouseconomics.com/2020/04/monetary-policy-10.html

Paul Krugman: Surprisingly "Upbeat" and Modest About a Post-Covid Recovery

Click here to read the original Cautious Optimism Facebook post with comments

5 MIN READ - New York Times columnist Paul Krugman is “upbeat” about the prospects for a post-Covid economy. Which means the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff is now officially worried.

OK in all seriousness, Krugman has given us something rarer than an objective reporter at MSNBC: an interesting interview which is almost as big a surprise to us as the post-2016 election stock market was to him. But in all fairness there’s a very un-Krugmanesque humility on his part regarding the novelty of the 2020 sudden full-stop depression.

(Interview at:)

https://www.bloomberg.com/opinion/articles/2020-05-27/paul-krugman-is-pretty-upbeat-about-coronavirus-economic-recovery

So Krugman might not win another Nobel Prize for disproving the broken clock theory after all.

However, in case anyone thinks the Economics Correspondent has gotten soft and joined the Legion of Krug there’s always the recovery, a phase where the Nobel Laureate will be tempted to fall right back into his Keynesian “stimulus” groove which we’ll discuss at the end of this column.

First the good and not-so-bad:

1) PK: “Is this a demand shock or a supply shock? Yes. And no. The aggregate-demand-aggregate-supply framework doesn't work well for this crisis.”

“What's happening now is that we've shut down both supply and demand for part of the economy because we think high-contact activities spread the coronavirus. This means we can't just use standard macro models off the shelf.”

So the Economics Correspondent agrees with this. For many sectors both the supply and demand curves have quickly gone “inelastic” and nearly vertical. On the demand side it doesn’t matter how low prices fall—for airline tickets or cruise lines or movie theaters, for example—because people are simply not going to buy many things at pre-Covid levels. 

Even those who are willing are often being prohibited by government social distancing restrictions, but absent those ordinances demand in most sectors will still be down considerably from 2019.

Likewise on the supply side it doesn’t matter how much people are willing to pay to go to a sporting event or a concert. The suppliers are simply not going to make more of their product available. Even when paying for in-person college classes or fitness clubs, schools and firms are going to severely limit supply to a fraction of original capacity, also either voluntarily or by government decree.

And the “can’t use standard macro models” comment reflects a rare little bit of humility from Krugman that this recession is unique in a way we’ve never seen before, and that it’s hard to return to one's favorite playbook that’s been used over and over before. It’s a very, very rare dose of modesty from Krugman who typically claims to know more than everything.

So don’t let it be said the Economics Correspondent doesn’t give credit where it’s due—even when it goes to an incurably wrong polemicist like Krugman.

2) PK: “The fall in demand isn't just households postponing consumption until they can go to restaurants again; it's also a crash in construction of houses, commercial real estate and so on. Who wants to build an office park in a plague?”

Krugman is referring to investment demand as well as consumer demand and he has a valid point here. That demand curve for major capital investment spending has temporarily steepened as firms are more interested in preserving cash to ride out an uncertain future than risking lots of money on a new investment projects.

3) PK: “My take is that the Covid slump is more like 1979-82 than 2007-09: it wasn’t caused by imbalances that will take years to correct. So that would suggest fast recovery once the virus is contained... …All that said, right now I don’t see the case for a multiyear depression. People expecting this slump to look like the last one seem to me to be fighting the last war.”

This is not a unique take, but it’s probably correct. Although it would be foolish to say there were absolutely no bad investments or economic imbalances in February 2020, the reality is there wasn't one giant sector whose economics were completely out of whack such as commercial real estate and the S&L’s that financed them in the late 1980’s, dot-com companies in the late 1990’s, or residential housing and the banks/mortgage companies that were partially compelled to finance them in the mid-2000’s.

However the Economics Correspondent would warn that the longer the virus goes unresolved, the longer the recovery will take since more and more households, firms, and financial institutions will experience losses that take longer to recoup, leading us to…

4) PK: “Another is that even if we didn’t have big imbalances before, the slump may be creating them now. Think of business closures, which will require time to reverse.”

Again, this is the moderate risk to recovery. The longer the negative effects of lockdowns, or partial-reopenings, or even the virus’ effect on voluntary consumer behavior, the more business that fail—typically small and medium sized although we have seen a few high profile large bankruptcies already such as Hertz, Neiman Marcus, JC Penney, and several energy firms that were already on the margin. And it will take time for the liquidated failures to either restart or more likely be replaced by some new entrepreneur who fills the gap left behind.

5) PK: “In particular, we know enough to understand why conventional responses like stimulus or tax cuts are inappropriate…”

Krugman surprises here recommending restraint on higher inflation and stimulus spending (gasp!), his favorite go-to Swiss army knife for all economic problems, but he also predictably dismisses tax cuts.

While tax cuts are a question of degree of economic benefit, and government stimulus spending is a question of degree of harm (or more specifically, postponing a recovery), the crisis phase is likely one where tax cuts aren’t going to have as positive an effect as usual. 

Again, a marginally higher incentive to invest isn't going to inspire many firms that are reluctant to risk large sums of investment capital while the future is so uncertain. Their focus is maintaining cash reserves to get to the end of the crisis.

Which leads me to where I think Krugman will drop the Doctor Jekyll routine and revert to Mister Hyde: during the recovery.

6) Will Krugman continue to be halfway reasonable when the crisis is resolved and America starts picking up the economic pieces and rebuilding? 

Don’t bet on it.

The Economics Correspondent has read Krugman for almost twenty years. Based on his writings, speeches, lectures and general ideology here is a back of the napkin prediction for Krugman’s policy stance in a year or two:

Once the virus itself is contained, if the economy shows even the slightest iota of sluggishness during recovery—that is, it doesn’t return to full employment within two quarters—Krugman will drop the “standard models don’t work in this new environment” humility and go right back to the Keynesian stimulus playbook.

Because joblessness might be 15% or 10% or 8% we will need to hasten recovery with aggressive government action, he will say. And it’s all the evil GOP’s fault for stubbornly refusing to borrow and spend another $2 trillion here or $3 trillion there or $4 trillion anywhere on a giant stimulus package. 

And even though firms will be in more of a risktaking mood once recovery is underway, Krugman will argue anyone who calls for tax cuts or deregulation to encourage more investment is just another free market/conservative neanderthal who doesn’t understand Macroeconomics 101 (ie. New Keynesian economics).

He may even call for the nationalization of healthcare as a “stimulus,” or a government “investment bank” as Keynes urged during the Great Depression, or something akin to the Green New Deal. And it will all come in lockstep with calls for tax hikes on businesses, investors, and the wealthy.

If Trump is still president he may find some common ground on a giant infrastructure spending package.

Because when the crisis has bottomed out and the upward recovery slope kicks in, Krugman will likely  toe the Keynesian “in the short run” line yet again, transforming back into the hammer that sees everything as a nail.

If Krugman surprises and doesn’t revert straight back to his personal obnoxious brand of New Keynesian orthodoxy then the Economics Correspondent will, in very un-Krugmanlike fashion, be the first to admit error. In fact it will be a pleasant mea culpa to see him remain civil and reasonable more than a few days. On the other hand I’ve also never seen a rattlesnake permanently forswear biting either.

Left Coast Correspondent: Chinese Propagation of Coronavirus to Globe Through International Flights Likely a Deliberate Calculation

 Click here to read the original Cautious Optimism Facebook post with comments

2 MIN READ - The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena offers a yet-unproven but highly viable theory to explain why the Chinese Communist Party allowed unrestricted international flights to leave Wuhan even as travel within China was locked down to contain the domestic spread of the Wuhan coronavirus:

General Jack Keane (ret.)

"Post-pandemic, there needs to be a comprehensive strategy in dealing with [what] China has done… …actually growing a pandemic from an epidemic by permitting international flights out of the country," [Chairman of the Institute for the Study of War Jack] Keane said.”

“The retired general theorized that China allowed the virus to spread because Chinese President Xi Jinping wanted to neutralize the advantage other countries could have gained while China struggled with the outbreak.”

“He doesn't care about loss of life. He cares about the economic contraction that was experienced in his country. And he wanted the other countries to go through that same economic contraction as he was going through," Keane said. "And he was hoping that he would recover sooner than they did. That's what this is about. And he's got to be held accountable for that."

Read full story at:

https://www.foxnews.com/media/gen-jack-keane-china-criminal-behavior-coronavirus

(Left Coast Correspondent’s comment) While no evidence is available to the outside that Xi Jinping and the Chinese Communist Party leadership calculated to deliberately allow the virus to spread across the globe and place the rest of the world at the same economic disadvantage China was experiencing, such a sinister decision would be perfectly consistent with Beijing’s inexplicable and contradictory domestic and international "containment" policies.

Within the first few weeks or even days of Wuhan’s lockdown it’s impossible for the CCP leadership not to have realized its epidemic controls would inflict immense damage on their economy. They also would have quickly realized the virus and the economic consequences of fighting it might stay with them for a long time, perhaps years. China’s own scientists and economists aren’t stupid and it would be naive to think they didn't put two and two together very early.

Therefore, knowing that the Chinese economy was “going down,” Keane theorizes Beijing made a calculated decision that “If our economy is going down, we’re going to make sure the rest of the world goes down with us so that we maintain our number two position in the world.” A regime determined to level the playing field by dragging everyone down to their disadvantaged level, no matter how low the playing field would go, would have done exactly what China did.

Analysis: Generations of Keynesian Policies Have Made Us Extremely Vulnerable to the Covid-19 Economic Crisis

Click here to read the original Cautious Optimism Facebook post with comments

4 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff was particularly impressed by this article’s thesis (“an economy starved of savings has little resilience to any shock”), but more for its financial insights than its traditional Austrian capital insights which he’d like to criticize oh so slightly.

Read FEE.org article here:

https://fee.org/articles/generations-of-keynesian-policies-have-made-us-extremely-vulnerable-to-the-covid-19-economic-crisis

For those not familiar with Austrian Business Cycle Theory (ABCT), the act of saving one’s income—which means deferring consumption—preserves a share of the real physical economy to be channeled towards producing capital tools and machines that enable greater production and higher standards of living in the future.

The article opens with the first of two major insights by establishing that when consumers spend all their income and more, they are signaling to businesses to focus more on producing goods for immediate consumption and less on producing capital goods that increase output per worker in the future. And over time sustained overconsumption leads to slowing economic growth as “seed corn is eaten.”

ABCT also argues that when central banks force interest rates down, they discourage saving and encourage more borrowing and consumption. Thus fewer capital goods are produced and the artificially low interest rate actually slows economic growth over any time frame beyond the short-term cheap money “sugar rush.”

There are more nuances to ABCT but the Economics Correspondent will stop there and say he generally agrees with the theory.

However the key economic disruption in the coronavirus economic crisis is not insufficient capital goods leading to meager gains in productivity.

Even if factories were flush with more modern capital tools and machines, the economy would still be in the hole now because government lockdowns and the virus itself are interfering with the ability of human workers to cooperate and employ those machines efficiently—not to mention managerial planning, maintenance of capital machines, distribution of intermediate and final goods and services, and the ability of end consumers to purchase them or take delivery.

Which leads to the second and stronger insight of the article regarding the Federal Reserve’s policy impact on the economy’s financial health.

It’s no secret that nearly a decade of zero interest rates has encouraged debt, debt, and more debt—taken on by firms, households, and governments.

Companies have leveraged to the hilt, floating huge debt offerings not only to finance expansion, but also to buy back stock.

https://fred.stlouisfed.org/graph/fredgraph.png?g=qVLI

While the Economics Correspondent has no objection to share buybacks per se, the zero interest rate environment has incited more financially irrational buyback schemes.

For example, paying a cheap 3.5% on corporate notes to raise cash to buy back shares that pay dividend yields of 4% might seem like a perfectly logical move to a CFO except that debt markets would never buy the notes at 3.5% to begin with were it not for Fed interest rate manipulation. Hence the unnatural math has spurred higher risk and higher corporate debt loads.

Borrowing to buy back shares also deprives firms of financial flexibility during a slump. When the music stops suddenly—as it has now—a company can suspend those dividend payments to preserve cash, but it can’t stop paying interest on the debt or refuse to repay it which would lead to bankruptcy.

Households have racked up record debt since 2008 as well. Although household debt as a percent of GDP is slightly lower than in 2008, household debt as a percent of household income is once again at a record. And just as importantly the gap between household debt and personal savings has never been greater.

https://www.bourbonfm.com/sites/default/files/users/PatrickBourbon/Personal%20Saving%20Rate%20%26%20Debt-to-Annual-Income%20Ratio.png

And of course there’s the government’s highly publicized national debt and debt-to-GDP ratio. After rising rapidly from 2009, the debt-to-GDP ratio stabilized somewhat in 2014 around 100% and has set new peacetime records slowly ever since, but that stabilization is about to change very soon for the worse.

https://fred.stlouisfed.org/series/GFDEGDQ188S

The Economics Correspondent predicts the national debt will very soon eclipse the all-time record debt-to-GDP ratio of 120% set during World War II.

All of these record levels of debt and low savings are the result of a central bank that forced interest rates to or near zero for over a decade. With such low rates the public would be crazy not to borrow and consume, and just as crazy to save—except for the highly disciplined few willing to stomach paltry returns and save anyway.

Which brings us to the crisis. Suddenly firms, households, and governments don’t see much income coming in. We’ve all been forced to hunker down and, even when that ends, will mostly still keep hunkering down voluntarily until the virus problem is unequivocally resolved.

A society that had accumulated ample savings—both corporate and household—would have a cushion to ride out the storm. It would be painful, but it wouldn’t have to be desperate, at least in the short-term.

But thanks to the Fed few firms and households found themselves in that favorable position in March when the crisis erupted.

The result is companies are scrambling to borrow even more to build that cash cushion (with the Fed accommodating them yet again), many that were previously overleveraged are going bankrupt, and households and small businesses—which unlike corporations have few capital assets to pledge as collateral—are left dependent on unemployment checks and government assistance since they have little savings to get through the slump.

Even the federal government doesn’t have the money and has to borrow to, among other things, bail out highly indebted state governments.

And why didn’t they have a cushion? Keynesian economic policies.

Central banks believed before and after the 2008 crisis that economic recoveries should be “stimulated” with record low interest rates that ultimately produced record levels of indebtedness. Ironically the Austrian criticism argues that super low interest rates lead to slower growth and slower recoveries over the longer term because the economy is starved of savings and deprived of real physical capital.

And the attached FEE article is dead on right that America’s companies, households, federal and especially state and local governments are in a far more desperate financial position now because of the Keynesian monetary policies of yesterday.

Left Coast Correspondent: British Intelligence says all Cell Phone Activity at Wuhan Virology Institute Stopped October 7-24, 2020

Click here to read the original Cautious Optimism Facebook post with comments

The now-secretive Wuhan Institute of Virology

The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena eagerly awaits any evidence Secretary of State Mike Pompeo claims United States intelligence agencies have accumulated proving the Wuhan coronavirus originated from the Wuhan Institute of Virology (WIV) laboratories.

Meanwhile British intelligence has recently ascertained that all cell phone traffic to and from the the WIV came to a sudden and complete stop between October 7 and 24.

https://nypost.com/2020/05/09/cellphone-data-could-indicate-october-shutdown-at-wuhan-lab/

Although a seventeen day cessation of all cell traffic is not conclusive evidence of anything more, it is highly unusual for an institute that employs large numbers of scientists/workers and would be consistent with a complete shutdown resulting from an accidental release at the pathogen-housing biolab.

Unfortunately all publicly disclosed evidence of a lab leak has so far been circumstantial.

1) The CCP claims the virus broke out at a wet market, but has reopened the country's wet markets for business anyway. Odd policy for a government that has stated such markets have demonstrated the capacity to unleash more pathogens that threaten the survival of all humankind.

2) The CCP claims the coronavirus just happened to break out in the one city that contains China’s only biosafety level 4 laboratory that also coincidentally stores and studies bat coronaviruses—an amazing coincidence given that same city contains 8/10ths of 1% of China’s population and 9/10ths of 1% of China’s land mass

3) A new study from University College London and University of Reunion Island, soon to be published in the “Infections, Genetics, and Evolution” scientific journal, has used worldwide genome sequence analysis to place the first Covid human infection date as early as October 6th. All cell phone traffic in and out of the WIV suddenly ceased on October 7th.

https://www.scmp.com/news/china/science/article/3083211/coronavirus-may-have-jumped-humans-early-october-study-says

4) The Chinese government began the destruction of documents and evidence as soon as the Wuhan breakout began.

5) Nearly all of the scientists and technicians who were working at the WIV at the time of the outbreak have disappeared, making it impossible for outside investigators to question them.

6) The CCP refused to allow American and other outside scientists into the WIV at the time of the outbreak, and has still refused any outside access six months later.

Or course physical evidence and testimony from key witnesses would be preferable to circumstantial evidence, but the Chinese Communist Party has made that impossible, consistently putting up obstacles and barriers to attempts by outside health and government authorities to ascertain what really happened at the WIV.

Explaining the Federal Reserve’s Coronavirus Policy Response Part 5: Is Runaway Inflation Inevitable?

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff ponders the likeliness that the Federal Reserve’s aggressive coronavirus easing will spark runway inflation.

Monetary Velocity: 2008-2015

Note: This analysis applies fundamental principles concerning the effects of money, output, and velocity on prices and inflation. For a primer on the basics of inflation go to:

http://www.cautiouseconomics.com/2020/04/monetary-policy-11.html

Since mid-March the Federal Reserve has flooded the financial system with new liquidity more quickly than during the depths of the 2008 financial crisis. Newly created reserves are being loaned out by commercial banks and multiplied into higher demand deposit balances.

So won’t all this new money spark massive inflation? Is our money doomed to go the way of the Venezuelan bolivar and become toilet paper?

In the Economics Correspondent’s opinion, the short answer is “very unlikely” although he won’t rule out a mild increase particularly in the near term—but not Weimar Republic Germany or Robert Mugabe’s Zimbabwe.

Some of the new money will spill over into asset markets, driving up the value of stocks and other securities which—while introducing a different set of risks longer term—have little effect on consumer prices and aren’t measured in official inflation statistics.

However the greatest counterbalance to the Fed’s monetary inflation will be falling monetary velocity which the Correspondent believes the Fed already considers a fait accompli.

X. OFFSETTING FALLING VELOCITY

There is no question the Federal Reserve is aggressively creating new bank reserves through extremely large asset purchases. In the March 11 to April 22 period total commercial bank reserves held at the Fed have risen from $1.72 trillion to $3.1 trillion, an increase of 80% in 42 days and a new record eclipsing the $2.8 trillion set in July of 2014 (see table 1, "Reserve balances with Federal Reserve Banks").

https://www.federalreserve.gov/releases/h41/current/h41.htm

The monetary base is also in record territory (see graph).

https://fred.stlouisfed.org/series/BOGMBASEW

Incidentally the rate of increase of both has slowed considerably from the operations’ frantic opening days.

The broader M1 aggregate, which reflects currency and commercial bank demand deposits (themselves the product of banks lending out reserves) has risen from $4.07 trillion to a record $4.52 trillion or up a more modest 11%.

https://fred.stlouisfed.org/series/M1

The even broader M2 aggregate has risen by $1.2 trillion during the same period from $15.66 trillion to $16.87 trillion, up even slower: 7.7%.

https://fred.stlouisfed.org/series/M2

But as we’ve already reviewed in the previous chapter on the Equation of Exchange (mv = py), final prices are influenced not only by changes in the money supply, but also by fluctuations in economic output (real GDP) and monetary velocity.

As we enter a major recession due to government social-distancing shutdowns and consumer fears of coronavirus infection, real output is sure to fall. Given that prices move in inverse proportion to output, a decline in real GDP will trigger an increase in prices.

So if, for example, the next quarterly GDP report reflects an epic annualized decline of 40%, then all things being equal the actual drop for the quarter itself (when not extracted on an annual basis) of 11.2% will propel a price inflation of 12.6% for the quarter alone.

Unnerving indeed. So why the downplayed inflation concerns?

Because—and this is a key concept—a fall in monetary velocity produces the opposite effect, a decline in prices. We have a recent example.

During the financial crisis single-year period 2Q2008 to 2Q2009 monetary velocity fell by 17% (see graph).

https://fred.stlouisfed.org/graph/fredgraph.png?g=qLgs

A 17% decline in velocity, all things being equal, will deflate prices by 17%. And applying the Equation of Exchange (mv = py) a 17% decline in velocity paired with an 11% increase in M1 and an 12.6% decline in output actually translates to a final inflation rate of 3.7%.

Now of course this is just a mathematical hypothetical using apples and oranges—a full year’s deflation, a quarterly GDP contraction, and a 42 days change in money supply. We don’t know yet what the M1 and GDP numbers will be by the end of the year, but the Economics Correspondent believes the Fed anticipates an even larger drop in velocity than 17% for 2020 and that the decline will easily outpace GDP’s in ensuing years as GDP resumes growth more rapidly than velocity.

The reasons aren’t hard to fathom.

Starting with a baseline of the 2008 financial crisis and its single-year 17% decline we can start making adjustments accounting for the more extreme economic conditions of the coronavirus crisis.

1) With nearly all of America under shutdown, consumers can’t spend on discretionaries and even some consumer staples, even if they have the means to do so.

2) Tens of millions of Americans will lose their jobs in the short-term. The lack of income will drive velocity down further.

3) Even when the lockdown restrictions are loosened, those Americans who still have jobs will forgo spending to bolster their savings as they worry about job security.

4) Even when the lockdown restrictions are loosened, Americans will be less willing to spend on most goods and services than before. Spending on travel, hospitality, restaurants, sporting events, many brick-and-mortal retail stores, personal fitness clubs, movie theaters—the list goes on and on—will fall to depressed levels until a cure or vaccine is widely available.

It doesn’t stop with consumers.

5) Firms have borrowed heavily and built liquid cash cushions to ride out the slump. However those reserves will be spent at a slower rate than before. With demand down across the board firms will be paying fewer workers, cutting back on operations, and abstaining from large capital investment projects.

The federal government is attempting to prop up spending and velocity with its $2+ trillion “life support” package, but borrowing and handing out trillions of dollars every month is unsustainable.

XI. RECOVERY

What about when the economy recovers?

Recent history shows in recessions GDP always bottoms out and recovers before velocity does.

In the 2008-09 recession, GDP bottomed out at about -5% in 2Q2009 before resuming growth at a very modest pace. However velocity’s fall remained persistent. By the end of 2015 velocity had declined by a whopping 44% and as of this article’s writing has still never reached a trough (see graphs).

https://fred.stlouisfed.org/graph/fredgraph.png?g=qNMS

https://fred.stlouisfed.org/graph/fredgraph.png?g=qNMP

Once again we can apply the Equation of Exchange.

Had the money supply remained constant from 2008 to 2015, prices would have fallen by 50% resulting in widespread bankruptcies as borrowers found it twice as difficult to earn the dollars needed to pay back fixed nominal debts.

In the 2000-01 recession, GDP bottomed out at less than -1% in 3Q2001 before turning around. However velocity continued to fall for two more years before bottoming out in 2Q2003, down 6.5% from the pre-recession peak.

So even though spectacular headlines of GDP contraction will dominate the news for a few quarters, the Economics Correspondent believes velocity will also contract and remain depressed for a longer period.

Hence the Fed’s aggressive quantitative easing and liquidity programs are designed to offset declining velocity. This doesn’t even include the Fed’s more publicized goals of ensuring firms have access to liquid dollar loans to survive, and at reasonable interest rates (rates would skyrocket is new reserves weren’t available—simple supply and demand).

The Fed hasn’t made many public statements announcing the velocity rationale for monetary expansion, but it has repeatedly reaffirmed its goal of “price stability and the 2% inflation target.” Obviously if velocity falls 40% over several years while GDP falls 10% or 20% and rebounds, price stability and a 2% inflation target won’t be achieved without adjusting the money supply.

Ironically, Austrian economist F.A. Hayek—possibly the most free market economist ever to win the Nobel Prize—advocated the same policy response in the early 1930’s and he also used the Equation of Exchange to reach his conclusion. Hayek argued mv (what he called “the flow of spending”) must be kept constant by central banks and that declines in spending—which the central bank had little control over—must be “offset” by expansion of the money supply.

However most central banks, most notably the 1929-1933 Federal Reserve, did the opposite. The Fed sat idly by and refused to make emergency liquidity loans to member banks. As 10,000 U.S. banks failed the money supply, far from expanding to offset declines in velocity, contracted by one-third in what would mark the darkest period of the Great Depression.

Ultimately Hayek gave up on his “flow of spending” proposals, not because he believed they were invalid, but because he lost confidence that central bankers were competent enough to carry them out. Later in his life Hayek ultimately came to believe a complete separation of money and state (free banking) was the best policy.

XII. WHAT IF INFLATION DOES START TO ACCELERATE?

The Fed’s strategy of offsetting declines in velocity with monetary expansion sounds good in theory, but carrying out the policy is a fine balancing act that requires constant monitoring of prices and the economy in general.

So what’s the Fed to do if it miscalculates and prices start to accelerate beyond its 2% inflation target? Is it powerless to restrain prices once they start to rise?

No, it has tools.

Since 2008 the Fed has used Interest of Excess Reserves (IOER) policy to control the quantity of bank reserves that are loaned out into the real economy. IOER is the interest rate the Fed pays member banks to sequester their reserves instead of lending them.

Since IOER interest is risk-free, safer than U.S. Treasuries since the Fed simply creates the interest paid out of thin air, banks are prone to sequester their reserves so long as the rate is attractive enough discounting for its zero-risk premium.

During the entire post-2008 period the Fed consistently paid a higher IOER rate than banks could earn on competing safe, short-term securities like 1-week, 1-month, or even 3-month Treasuries. This achieved its goal of loading banks up with trillions of dollars in reserves during the crisis to enhance their liquidity positions while preventing those reserves from being unleashed on the real economy and sparking runaway inflation.

https://www.cato.org/sites/cato.org/files/styles/pubs_2x/public/download-remote-images/cdn.alt-m.org/277165213523/DB_altm1.png?itok=KcDSesq-

The Fed will use the IOER rate as its primary policy tool during and after the coronavirus crisis as well. If the Fed sees inflationary pressures building, it will raise the IOER rate to impel banks to moderate lending enough to restrain the inflation rate.

Over the next several quarters the Economics Correspondent will monitor increases in monetary aggregates and compare them against changes in real GDP and velocity. While unwilling to bet his life's savings on it, he anticipates:

-Higher monetary aggregates

-An initial sharp GDP contraction followed by a slower recovery (although rapid compared to previous recoveries due simply to the size of the initial contraction)

-An even sharper contraction in velocity that persists long after GDP bottoms out.