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First You Need An Army Is It Bush We Are Testing to Destruction?

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A Case of the Economic Shivers

by Christopher Chantrill
June 04, 2006 at 10:02 am

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THE FINANCIAL markets gave a convulsive shiver a month ago when the Fed raised its Fed Funds rate to 5 percent and allowed as how it might well pause in its monthly quarter-point increase action. Oh no you don’t, came the unmistakable response, as global stocks, the dollar, US government bonds, oil, and gold all tanked.

That means that the rosy scenario, in which the Fed would tighten up to the 5 percent level and then benevolently pause while the national economy continued to grow comfortably along at 3.5 to 4.0 percent per year is probably defunct. Interest rates are going on up, almost certainly to 6 percent or higher. It also means that the pips are going to start squeaking as people who have borrowed on low interest ARMs have to adjust as their adjustable rate mortgages adjust upwards.

British investment banker Sir Siegmund Warburg had another term for “rosy scenario.” According to Professor Niall Ferguson, he used to talk about “wishful non-thinking.” It’s a pity that Sir Siegmund’s chosen successor at SG Warburg, Sir David Scholey, didn’t listen to his mentor. He overextended Warburg during Fed Chairman Greenspan’s tightening in 1993 and had to sell the investment bank to Swiss Bank Corporation.

The problem is to find a balance between a healthy optimism and the “wishful non-thinking” that ignores the inevitability of a train wreck when an onrushing locomotive is already in sight thundering down the track.

Are we heading for a train wreck like 1980 when inflation, interest rates, and unemployment were all hitting 10 percent? Or is this 1990, when the S&L meltdown was, finally, handled by liquidating the malinvestments of S&L barons like Charles Keating to the tune of $500 billion or so in government bonds? Or will the US economy power ahead and continue to confound its critics?

The Federal Reserve Board has two jobs. One is fighting recession. That is the fun part of its job. The other job is fighting inflation. That is the unpleasant part of the job, the role of the kill-joy who snatches the punchbowl away just when the party is getting lively.

Right now, the Fed is in transition between its two jobs. It had a grand old time in the early Noughties, spiking the punchbowl with low interest rates until it got the Fed Funds rate down to 1.0 percent. What a party Americans had, refinancing their mortgages, buying and building mega-mansions and starter castles, boosting real-estate prices into the stratosphere on the high octane fuel of cheap credit. Now the Fed has its hands on the punchbowl and it is impatiently looking at its watch.

What will the Fed do? Will there be a dollar crisis? Will there be a housing crash? Will there be a nasty recession? Nobody knows. Right now people are placing their bets, and hoping that they are not indulging in “wishful non-thinking.”

Years ago, a wise old head wrote that the most important issue for the federal government is not fighting inflation, or growing the economy, or even saving Social Security. For the government, job one is to float its paper: its debt and its paper money. As long as the bond market is buying the government’s bonds, notes, and bills, and people are willing to hold its paper money then everything is fine. It is when the government loses the confidence of the bond market and cannot sell its paper or when people start pushing money around in wheel-barrows that people start to tremble.

Think Germany in 1923, Nationalist China in the late 1940s, Argentina in 2001, Zimbabwe in 2006. These are loser governments. In 1980, of course, at the height of the Carter inflation, there was a bobble or two of worry about the United States on the loser front.

On the other hand, the finest hour of government finance has to be the US government’s financing of World War II. The government cranked the deficit up to 40 percent of GDP; the Treasury floated an ocean of bonds; the Fed bought a lot of those bonds to keep interest rates down, and they barely broke a sweat.

Isn’t it interesting that President Bush has just nominated the king of Wall Street, Goldman Sachs boss Henry M. Paulson Jr., to be Secretary of the Treasury? Pretty soon he’ll be traveling the world humming Irving Berlin’s old song:

Any bonds today?
Bonds of freedom
That’s what I’m selling
Any bonds today?
Scrape up the most you can
Here comes the freedom man
Asking you to buy a share of freedom today

You can see where President Bush has placed his bet. But no “wishful non-thinking,” please, Mr. President.

Christopher Chantrill blogs at www.roadtothemiddleclass.com.

Buy his Road to the Middle Class.

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Faith & Purpose

“When we began first to preach these things, the people appeared as awakened from the sleep of ages—they seemed to see for the first time that they were responsible beings, and that a refusal to use the means appointed was a damning sin.”
Finke, Stark, The Churching of America, 1776-1990


Mutual Aid

In 1911... at least nine million of the 12 million covered by national insurance were already members of voluntary sick pay schemes. A similar proportion were also eligible for medical care.
Green, Reinventing Civil Society


Education

“We have met with families in which for weeks together, not an article of sustenance but potatoes had been used; yet for every child the hard-earned sum was provided to send them to school.”
E. G. West, Education and the State


Living Under Law

Law being too tenuous to rely upon in [Ulster and the Scottish borderlands], people developed patterns of settling differences by personal fighting and family feuds.
Thomas Sowell, Conquests and Cultures


German Philosophy

The primary thing to keep in mind about German and Russian thought since 1800 is that it takes for granted that the Cartesian, Lockean or Humean scientific and philosophical conception of man and nature... has been shown by indisputable evidence to be inadequate. 
F.S.C. Northrop, The Meeting of East and West


Knowledge

Inquiry does not start unless there is a problem... It is the problem and its characteristics revealed by analysis which guides one first to the relevant facts and then, once the relevant facts are known, to the relevant hypotheses.
F.S.C. Northrop, The Logic of the Sciences and the Humanities


Chappies

“But I saw a man yesterday who knows a fellow who had it from a chappie that said that Urquhart had been dipping himself a bit recklessly off the deep end.”  —Freddy Arbuthnot
Dorothy L. Sayers, Strong Poison


Democratic Capitalism

I mean three systems in one: a predominantly market economy; a polity respectful of the rights of the individual to life, liberty, and the pursuit of happiness; and a system of cultural institutions moved by ideals of liberty and justice for all. In short, three dynamic and converging systems functioning as one: a democratic polity, an economy based on markets and incentives, and a moral-cultural system which is plural and, in the largest sense, liberal.
Michael Novak, The Spirit of Democratic Capitalism


Action

The incentive that impels a man to act is always some uneasiness... But to make a man act [he must have] the expectation that purposeful behavior has the power to remove or at least to alleviate the felt uneasiness.
Ludwig von Mises, Human Action


Churches

[In the] higher Christian churches... they saunter through the liturgy like Mohawks along a string of scaffolding who have long since forgotten their danger. If God were to blast such a service to bits, the congregation would be, I believe, genuinely shocked. But in the low churches you expect it every minute.
Annie Dillard, Holy the Firm


Conversion

“When we received Christ,” Phil added, “all of a sudden we now had a rule book to go by, and when we had problems the preacher was right there to give us the answers.”
James M. Ault, Jr., Spirit and Flesh


Living Law

The recognition and integration of extralegal property rights [in the Homestead Act] was a key element in the United States becoming the most important market economy and producer of capital in the world.
Hernando de Soto, The Mystery of Capital


presented by Christopher Chantrill

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