VOLCKER: TAX INCREASES COMING SOON TO AN ECONOMY NEAR YOU
I have generally been a huge fan of Paul Volcker’s. Few men in government have been in favor of taking our medicine when we had to, but Volcker has always been willing to bite the bullet and take some pain in order to make some gains. His rules proposals on regulation and his hard monetary stance in the 70′s are two of the greatest contributions to this economy in the last 30 years. Unfortunately, his latest message is one of potential disaster. Just when the U.S. consumer is beginning to show brief signs of strength Volcker brings up the dreaded D word followed by the even more dreaded T word. Those of course are deficits and taxes. Speaking to the New York Historical Society, Volcker warned of potential tax hikes coming down the line. In reference to a question on the budget deficit Mr. Volcker said:
“If at the end of the day we need to raise taxes, we should raise taxes.”
He elaborated by adding that a tax similar to the recent hikes passed in the U.K. would not be a bad idea. Not a bad idea I ask? Talk about a great plan to derail the consumer and any shred of recovery we might be seeing. Now, if Mr. Volcker had said the following I might not be outraged:
“Inflation is beginning to run a little hot and unfortunately, we’ve spent a great deal of money on banker’s salaries, stimulus plans and healthcare in the last 12 months so your taxes are going to be raised”.
But tax hikes in the name of balancing the budget? It’s now quite clear that Mr. Volcker can be added to the crew of leaders who don’t understand exactly how our monetary system works (yes, it is as frightening as it sounds and unfortunately, entirely true). We do not fund our spending via taxes. We do not print bonds to finance our spending. China is not our banker. Neither is Japan and neither is anyone else. As the sovereign issuer of the currency in a non-convertible floating exchange rate system we simply print money and control the money supply via monetary operations, taxes and spending. At a time when inflation remains low, the output gap high, unemployment at 25 year records and low capacity utilization there is almost no fear of runaway inflation. In fact, deflation remains the greater threat despite Bernanke’s attempts to reflate via mal-investment (which is running hotter than I am comfortable with). Regardless, Mr. Volcker is not worried about this. He is clearly catering to the fear mongering of the deficit hawks and those who truly believe we can default on our national debt. He is wrong.
Raising taxes of any kind at this time is a severe hurdle to any economic recovery – even if done for the right reasons. This is not only the wrong reason to raise taxes, but a horrible time to raise taxes. The consumer remains too fragile, the private sector too indebted and aggregate demand too low. The British have already made this fatal mistake. Let’s not follow their lead. The private sector remains far too fragile for such a misstep.
Read Armstrong’s criticisms of Volker’s interest rate hikes. Doubled the debt all by himself. Interesting stuff.
I like Volker as well.
Tax hikes are certain. The dems are going to balance the budget and get
this country back in fiscal shape.
Granted there is very little inflation when looking at the CPI, but when you look at assets prices like oil, copper and other base metals there does appear to be inflation because based on inventories their prices are not justified.
And for those of you who are going to say its because of peak oil, peak copper, peak aluminum…. Where were those concerns a year ago?
I think the Fed makes a huge mistake by not looking at asset prices when determining interest rates. The CPI was relatively tame during the housing bubble, so they weren’t worried, but where inflation was occurring was in home prices.
The bottom line is all this liquidity injected into the economy has to go somewhere and right now is flowing into stocks and certain commodities.
I’m starting to lean away from the deflation camp towards the stagflation camp and will move over there if the Fed doesn’t start raising rates soon.
I think we’re headed towards stagflation even though we’ve been mired in deflation for some time.
This time it may be different but we learn history and hopefully not repeat it.
Worst case is mother of all stagflation making the late 70′s stagflation a child’s game. BTW – world oil price rising dramatically was one of the main culprit of sharp inflation in the late 70′s and any political spark in the volatile middle east can trigger this.
For the record:
Stagflation is a condition of slow economic growth and relatively high unemployment – a time of stagnation – accompanied by a rise in prices, or inflation.
Sounds familiar? Next stop of this government pumped twilight zone economy is inflation leading to the dreaded STAGFLATION.
there is little doubt this will happen
It’s now quite clear that Mr. Volcker can be added to the crew of leaders who don’t understand exactly how our monetary system works (yes, it is as frightening as it sounds and unfortunately, entirely true).
TPC, you are pushing the envelope, don’t you think? The guy has been behind the bar so many years that I think he knows what he is talking about. You might disagree with his idea of raising taxes at this stage, but to say that he does not understand the system, with all due respect it sounds a little bit arrogant to me. You are starting the same debate again on technicalities about the monetary system and you might miss the real point: everything is a matter of perception, and perception is more important that any theoretical considerations in the real world (and in the fantasy world of markets too), especially when the markets are in panic mode. Yes, you can “theoretically” print as much money as you want but practically you can’t do that. why? because you are just debasing your currency and if in the end the market don’t want your “paper” anymore (because it’s obviously getting worthless) you might have a currency crisis on your hands that can send the USD to the toilet. Default doesn’t necessarily mean that you can’t pay back your debt because you don’t have any more money (this cannot happen to the states). It means also that you have no choice but to pay back your debt with a worthless paper. I think that Volker’s point is only that at some stage you will have to raise taxes to get the money somewhere and try to balance the budget (again matter of perception), as opposed to just print the money. If it was that easy everybody would do it…
ohhhh,…..tho i agree, he’s not gonna like this
thanks, finally some reason in this debate. Just to add TCP says aggregate demand is too low and capacity utilization low as well. It seems in market economy you adjust capacity to demand (thats what recessions are for); here we try to inflate the demand side and jobs and that is supposed to lead to long lasting prosperity?
I don’t know how many times I have to say this before readers stop beating this dead horse:
NO ONE EVER SAID YOU CAN PRINT AND PRINT WITHOUT REPERCUSSIONS!!!!!!!!
I have never said that. In fact, I keep repeating exactly the opposite. But that doesn’t change how our actual monetary operations work. We do not fund our deficits via bond issuance. This is not some theory I came up with. It is how our banking system works.
Sorry if it comes off as “arrogant”, but personally, I am surprised there aren’t more people like me out there challenging the intelligence of the men and women who almost flew the economy into the side of a mountain last year. You seem to trust these people without hesitation….The true arrogance here is that Bernanke, Geithner and Co. claim to have all the solutions when in reality they are the ones who have been piloting this bumpy ride for the last 5 years+.
suppose the head of the fed, which is independent of the executive and legislative branches, tells the treasury to shove it when the treasury wants it to hit the red button (print more money)?
isn’t the only recourse available in that situation is for the treasury to either issue more debt or, if there are no takers, default?
why should the fed issue more liabilities (create reserves/money) when to do so would be to risk inflation, which is the fed’s problem to monitor? couldn’t one envision a situation where the fed says that it, not the treasury, is in charge of the printing presses and it has made a determination that it is in the best interests of the dollar to not issue any more?
The two are practically synonymous. This whole myth of “fed independence” is just that. Did no one else see Bernanke and Paulson practically lip locked throughout 2009?
They work in tandem despite the myths that persist. Which is one reason why I think we should just mesh the two. Make the Fed accountable just like Congress.
i agree that greenspan was a total political creature, and that while bernanke was just trying to deal with the hand dealt, he did so in a fashion that furthered the status quo, but my point remains.
suppose you had someone with backbone as fed chairman who really thought the best interest of the fed and the country was to say no (volcker comes to mind); he might say to timmy g, if you need some dollars to retire a maturity of treasuries coming due, go out and issue more debt or raise some taxes, you are not getting any more dollars from me.
i suppose in that case, in the event the treasury couldn’t or didn’t want to raise taxes or issue more debt, congress could repeal the federal reserve act of 1913 and hand the printing press over to timmie g…but in that situation the default has really already occurred.
One other distinction also comes to mind: the Fed isn’t printing bills when we talk about “printing money” (though they do this, its not relevant to monetary policy). Instead, they’re increasing credit. Granted, that credit may be at 0% or 0.25% but the banks don’t go out and issue that credit to consumers at the same rate. Thus, if no one wants credit or credit demand is stagnant, then inflation of the money supply does nothing. It sits in Bank coffers performing no function and creating no money or demand. This is where the arrogant Helicopter Ben has been gravely mistaken.
I think the Fed is secretly scared shitless. They have no control over the system anymore and the PPT is NOT bigger than the rest of the world (despite what they may think). The Treasury and the Fed are certainly in this together, there’s no doubt about that.
actually, the fed IS printing money.
only the fed has the capacity to create a liability on its balance sheet, and liabilities on its balance sheet are money, as opposed to credit, which is what private parties extend to each other.
pull out any size dollar bill out of your wallet and take a look at it…it is a reserve note issued by the fed. no one else can do this.
there is a distinction between currency (the bills in your wallet) and reserves at the fed, but they are both money.
Hmm, I think you completely missed the point. Obviously the Fed LITERALLY prints money, but that’s not the discussion at hand. The Fed can lend money directly to Banks at a fixed rate (ie. discount rate) and the Fed can lend to banks OR banks can lend to each other at a target rate (ie. federal funds rate). The second is free floating, but the Central banks have the ability to manipulate this number by injecting short term loans at values above or below to shift the curve (ie. when the market panics and no banks lend to each other or lend at a high rate, say 7%, the Central banks step in with a liquidity injection by lending at 4%).
Yes, the Fed and the Central Bank DO increase the overall amount of Currency in circulation as its necessary for a number of reasons (think what would happen if the population increased but the amount of money did not….) but this it not done via the printing press. Cash reserves come secondarily to monetary policy which affects them.
TPG,
You claim that your description of how our monetary system operates is not a theory but the reality. I heard this statement from many proponents of different descriptions, and i am not going to argue about that….
Could you kindly, based on your understanding of the reality of your monetary system, explain what should be done in terms of monetary/fiscal policy to resolve current crisis and/or to minimize its consequences. Also, as many people here, including yourself, argue what constitutes “too much” or “enough” money printing, could you provide some quantitative basis for your explanation, something like “…. instead of increasing taxes by $500b annually, the government should print $500b every year and distribute them in such and such manner…”. Thanks a lot in advance.
BK
BK,
Thanks for the comment and keeping an open mind. I don’t claim to have a magic bullet either. But I think I take a broader and more open perspective on things than many.
For instance, I am one of the few people I know who takes the social aspects of our economy very seriously. I understand what the true driving force behind money accumulation really is. It’s a desire to provide for ones self and ones family. What has been so beautiful about capitalism is that it rewards hard work and not failure. What we have done over the last 18 months is reward failure. That is not capitalism. And this has meaningful social effects. It has created a disparaged outlook from most Americans. A disbelief in government, the economy and the banking system in particular.
I have proposed an Austro-Keynesian approach. One where we do not reward failure, but also utilize the strength of our government to ensure against depression or economic collapse. Unfortunately, much of the spending over the last 18 months has been wasteful which is not a huge surprise. I was in favor of an RTC approach to the banks. Force them to fail, but don’t allow them to crush the economy as they fail. Controlled demolition as I often refer to it….The losers must lose. Likewise, the housing subsidies are all self defeating. Another very poor form of government spending.
I would cut taxes, ramp up infrastructure spending (high speed rail system would be nice) , force the losers to lose and reinstate Glass-Steagall or some form of it so that we can stop rampant financial fraud and speculation. This way, we sustain aggregate demand while maintaining the credibility and faith of the capitalist markets….That’s the short version at least….
“I was in favor of an RTC approach to the banks. Force them to fail, but don’t allow them to crush the economy as they fail. Controlled demolition as I often refer to it”
tpc, i respect your work very much, especially when it goes against the tide…which is the best way to make a decent investment return…but you are missing the boat here, imho.
i did alot of work representing counterparties to the RTC resolution of the S&Ls. a similar resolution of money center banks would have been a huge clusterf**k and a big mistake.
the assets that would have to be sold by the money center banks under bankrupty/resolution authority would have been voluminous, highly complex and requiring huge amounts of due diligence and analysis by the buyers…and who would have been the buyers in such a situation? gs, jpm, wfc? no way, they would have been in resolution too (notwithstanding their protestations to the contrary; if the US went the nationalization/resolution route, they would have lost their funding as well and would have been sellers, not buyers).
You are looking at this from an airplane at 30K feet. i have been at the mess at ground zero working counterparty to the rtc (which by the way hires agents to do all of their work, and since the best agents want the most compensation, the best agents work for the buyers, not the rtc, so it all resembles a massive muddle through).
the rtc experience was a giant mess that over time worked out well enough for government work…but for a resolution of wall street itself, feggadaboutit!
one more thought occurs to me.
one could conceive of an expedited money center bankruptcy process along the lines of the gm process…do a contrived 363 sale to a newco and leave all of the shareholders and underwater creditors suck wind at oldco…but that would require the recapitalization of a newco, which gives rise to a valuation/should i invest? analysis that really is the same situation faced by putative buyers in a more conventional resolution process. the investment analysis for newco shareholder/creditors would have been fraught with anxiety, given the visible carnage done to the oldco shareholders/creditors. i have no idea where the investors would come from…maybe russian oligarchs who have played the game before…
i think an underestimated benefit of the process that we actually did go through was speed…the bailout investment was recouped in about a year, and if big ben does his job well, the fed balance sheet will eventually return to normal.
i think most people don’t realize that this was the best result out of universe of truly noxious alternatives. we all focus on the moral hazard implications, which is fine, but the alternative damage to the financial system of a slower resolution process would have been FAR worse, imho.
there would have been a controlled demolition at 30K feet, but at ground zero, far too many people would have been hurt!
I am not sure how anyone can come to the conclusion that the RTC was a huge mess. You seem to be living in this fantasy world where capitalism can function if the losers never lose.
You’re claiming “mission accomplished” about a decade before the evidence is in. Everyone said Greenspan was a genius in the 90′s, but Bernanke has essentially rehashed his playbook.
It’s hard to imagine that we’ve actually solved anything as opposed to kicking the can down the road to pay the piper at a latter date….What have we actually changed? Nothing in my opinion. And that means history is likely to repeat itself. When? Who knows. But this is not the last of the credit crisis….
“It’s hard to imagine that we’ve actually solved anything as opposed to kicking the can down the road to pay the piper at a latter date”
i am saying it was better to kick the can than to crush the can…we can agree to disagree on this one.
Chris,
We basically nationalized AIG and Citi and that has worked our pretty well without the remorse that has been attached to actually handing Goldman Sachs 10′s of billions.
What is the difference? We could have done that on a much larger scale, punished the losers and still come out of it okay. Except we wouldn’t have teaparty movements all over the country and rampant hatred of bankers and capitalism.
AIG worked out well???? To what exactly are you referring? That’s a $134 bln black hole that will almost certainly never be recouped. Fannie and Freddie are even uglier. GMAC is ugly but didnt hit nearly as many branches of the ugly tree on the way down.
AIG’s actions should never be allowed to happen again. If there’s one company that deserves a lion’s share of the blame, this is the one.
The paying out of CDS contracts triggered by credit downgrades and such was a CONTRACTUAL OBLIGATION. If the government were to violate those, well then you might as well toss capitalism straight out the window. Demonizing all the remaining workers there and their bonus pools was again, a really stupid thing to do – would you insult the doctors employed with fixing the mistakes of your previous doctors? The government has been absolutely immature and immoral in this whole process by not accepting enough of the blame for their own failures to regulate business as that is one of the core principles behind any governing body. By deflecting it elsewhere and demonizing others (and putting people’s lives at risk with said Witch Hunts), they’ve openly displayed the lowly lows they are willing to pursue to save face.
Lots of finance has taken huge pay cuts. How about the government? Where’s their penalty? How about the ignorant buyers? Ok, they lost a home or car they didnt deserve to begin with (and perhaps a job as well). But they’re not the victims. The rest of us who didn’t default ARE THE VICTIMS. Moreover, why is there no uproar about those underwater debt holders who will have their payments lowered by the government?? Why are the renters (who get no tax breaks) as well as those who were “small enough to fail” so silent??
Ugh, its sickening. The finger pointing has to stop because there aren’t enough fingers to point out all the entities involved.
danish,
i disagree. we did not nationalize either aig or c; if we did so, we would have zeroed out the equity and as much of the debt as barney frank or some other numbnuts cared to, and then injected fresh capital and new debt either from new capital sources or from taxpayers…
now you may say that the equity was already bubkis in both, and i can’t dispute that, but if we wanted to do a real nationalization, then a FDIC type takeover would have occurred…and i am saying that would have been a real effing mess if applied to the money center banks.
i do agree with you that aig and c have turned out well; by this i mean the taxpayers are likely to be repaid at a fair profit over time.
You’re essentially taking the perspective that Bernanke does: “we can’t let any bank fail because it will destroy the whole economy!!!”
That’s just another form of fear mongering that protects the interests of the super wealthy bankers.
Capitalism doesn’t work if the losers never lose. We’ll find out in the coming decade….
For kicking the can down the road a bit further, we have essentially guaranteed a persistently high unemployment / underemployment into much of this decade. This implies that GDP going forward will be abysmal once .gov will be force to remove stimulus spending. From this one could gather that .gov will try to shift the GDP pies around. With financial occupying almost 16% of the pie but having relatively a small workforce, there will be a redistribution of the wealth. My guess is that much of the financial wealth will flow through the .gov (via UST perhaps) to be channel toward a bigger .gov footprint (lower unemployment, under-employment). Just my take on where all this is leading perhaps.
The problem with your Austro-Keyensian approach is that the government doesn’t know whether the stimulus spending will succeed or fail until after the fact. If the project turned out to be a failure, the mal-investment would already have been made and wealth would have been destroyed or redistributed inefficiently. The result is usually COLLECTIVE PUNISHMENT on the citizenry via higher taxes or devaluation of the currency.
Thanks for voice of sanity TPC.
One cannot avoid the cause and effect. Pumping the economy with printing presses running 24/7 will eventually lead to post WWI German Weimar Republic and recent Zimbabwe. Why? Fed has primed and pumped liquidity to another bubble and will not be able to stop their easy money policy for the fear of market collapse. In the mean time the bubble is getting bigger…
TPC, sorry to make you jump on your horses! There are indeed many people out there challenging what these guys are doing and disagree with their policies, unfortunately none of them (or only few of them) are in the government and can really do something about it. Volcker is probably one of those, and I don’t think that he has any responsibility in the current crisis, so for the sake of your arguments you should not mix people: Bernanke, Geithner and Volcker are 3 different people.
Well, I apologize if you think I am being a bit hard on Mr. Volcker.
TPC Volcker knows very well how the monetary system works. He also knows they have to create the perception that the government is doing things ‘the right way’. Like balancing the budget. Even if the government buys most of the debt. It is all illusion. He knows this. So does Bernanke. So does China for that matter. But if the U.S. wasn’t doing this, then the world economy would look very different, so everyone high up in the world is O.K. with it. That is why China and Japan buy treasuries sometimes. So it can look sane.
Yeah, it’s almost funny to hear all this stuff about “Repo 105″ in regards to Lehman’s shady accounting. The Treasury is king of “Repo 98″, otherwise there’d paper all over the floor.
The debt that irresponsible homebuyers owed was just transferred from the banks balance sheets to the Feds. It still has to be paid however. I think this thing will come full circle when the markets go from questioning the integrity of the American consumers debt/capicity to that of the American government (and other soveriegn governments) quality of debt. If you look at history it was questining the integrity bonds and their defaults that caused the great depression NOT the stock market crash of 1929. In the end this all has to be ‘paid for’ and that will mean higher taxes for all and responsibility will have to come back and be in vogue again. Presently responsible spending/saving exists neither in the american consumer nor american government.
Do people really think that the goal has been to strengthen the US economy? The moves have been toward making the the average American dependent upon the government intervention and handouts. Stalin understood this when he said that the best way to enslave the populous was to strip them of everything and make them depend upon you for warmth and food. I won’t claim that is our gov’s goal but I’m often left scratching my head at these kind of moves.
Volcker’s reputation is based on the myth that his monetary wizardry slayed the inflation dragon in the early 80s. Nothing could be further from the truth.
•In his first three years as head of the Fed, inflation averaged 9.88%
•In his first six months in office, gold prices rose 283%
•Over the next 18 months, gold prices fell 66%
•During his first three years in office, the unemployment rate rose 68.3%
•In the third year of his term, the Mexican crisis hit
Now what part of that record screams an understanding of the monetary system? Volcker’s reputation would be that of a failed central banker if he hadn’t been lucky enough to serve while Reagan was President.
http://alhambrainvestments.com/blog/2010/02/10/the-man-the-myth-the-legend/
People like to give Volcker a lot of credit because he happened to be in charge during the beginning of the greatest bull market ever. This was pure happenstance. He is not some genius as everyone likes to think. He is as incompetent as Greenspan and Bernanke as your piece shows.
DanH, the “piece” doesn’t show or prove anything. To discredit or undermine someone’s reputation, competence or intelligence because of one or two statements that you disagree with is horseshit (excuse my French). You are free to make your comments but you should refrain to make this kind of reasoning and judgment ‘a l’emporte piece’ because it does not bring a shred of input in the debate. FYI, I am not at all an admirer of Volcker and I don’t put him on a pedestal.
I am no expert on how tax cuts will or will not impact the economy, but I am 100% with TPC on this one – how can everyone have such unending faith in these leaders of ours? We have been on a rollercoaster ride for 25 years as bankers get rich, Congress makes more money and the middle class gets slammed with higher taxes, stagnant wages and less jobs.
How come no one is questioning the integrity and intelligence of these men, who, as TPC puts it, just took us through the hardest of hard landings? This wasn’t mechanical error. This isn’t Sully Sullenberger. This is pilot error. No one here seems too upset about it though.
A lot of people are upset but the problem is a deeper one. Democracy works by electorate voting for people who promise them the most not by voting for people who are most qualified (how would you even measure that in advance?). And that’s the problem, countercyclical policies (increasing demand during recessions, taking it off during expansion)do not work in democracy! Poeple will not vote for fiscal responsibility but for empty promises so maybe at the end we are all doomed?
I understand the concept of vertical and horizontal money, and I am right with you, TPC on Tiny Tim, Greenjeans, and B squared. I don’t know if they just don’t understand how things work or if they are just willing dupes for the powers that control things. I personally think it is a little of both. Volker must have some understanding of how money works because what he did in th early eighties was either understanding or a happy accident, because it worked to end the price/wage spiral of the seventies. However what we have now is so completly different that any thought of applying the same remedy would be useless. Any inflation that exists currently and for the last 20 years or so is in Assets only. Oil and Gold are considered by many to be assets also, so i think it can be confusing because oil is involved in the production of so many products, not to mention the transportation of those products. Volker proposing tax increases is so out of left field that it makes me wonder just what he is thinking. The middle class is already being bombarded by loss of interest income to bail out bankers, loss of income due to the loss of employment, loss of wealth due to the eroding value of the middle classes two main assets- homes and 401k’s, potential losses from legislation such as health care, or even cap and trade, not to mention states and localities that are raising taxes to pay for the profligate spending of the last 20 years. How on earth can federal tax increases even be considered when all these other forces are combining to restrain or curtail spending by households. And I’m not even talking about discretionary spending, just spending on neccesities.
once again the best pro and con,yin and yang, give and take……….. on economics,investing and sometimes social philosophy, on the internet without most of the usual inane comments…..
You heard it from me before you heard it from Volker. In the comment section of the article about horizontal & vertical money creation on 4/5/10.
The government may create “bookkeeping” entries, but I anticipate that those entries will cost me real dollars (wealth) in the future.
Little did I know that the machine was already working.
Deficit = Taxation
Taxation = Reduction of my wealth