Federal Reserve and Monetary Policy: Chavez's Curve Ball

Venezuela's pres. Chavez has made good of his promise regarding giving heating oil for the poor. Call it what you want, but the reality of the situation can not be denied. The United States of America has a very big rift. This rift is so big as to allow a populist, Chavez, to gain political allies. Wall Street is going to come back from its holiday and contend with the possibility that, at the minimum, Bush has to answer this challenge and become side track to the point were his agenda is now dead and buried. The other end of the spectrum is the possibility of class warfare. One should expect social unrest when it becomes a government policy (one can include Wall Street) of placing more value on land rather than on its people (serfdom and feudal lords).

Russia's Proletariat vs Bourgeois is the closest historical event. An unpopular war (WWI) and an unpopular leader (the Czar). Mix in some economic hardships for the serfs and a social elites/aristocrats and poof, a revolt.

Oil or to be more precisely the value of Oil is not the main cause. I do admit that it is a factor, but it is not that which causes economic instability. I will explain by making the following observation (without proof): “Economic system under a Monarch/dictatorships and economic system under a “pure” capitalist sociality are duals to each other”. In the long run, these economic systems prevent upward mobility and are, therefore, unstable.

The closest economic system of the current global economy is a mercantile system. A handy source is Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations
Excerpt from “Of the Principle of the Commercial or Mercantile System”;
“Others admit that if a nation could be separated from all the world, it would be of no consequence how much, or how little money circulated in it. The consumable goods which were circulated by means of this money would only be exchanged for a greater or a smaller number of pieces; but the real wealth or poverty of the country, they allow, would depend altogether upon the abundance or scarcity of those consumable goods. But it is otherwise, they think, with countries which have connections with foreign nations, and which are obliged to carry on foreign wars, and to maintain fleets and armies in distant countries. This, they say, cannot be done but by sending abroad money to pay them with; and a nation cannot send much money abroad unless it has a good deal at home. Every such nation, therefore, must endeavour in time of peace to accumulate gold and silver that, when occasion requires, it may have wherewithal to carry on foreign wars. “
...
“They represented, secondly, that this prohibition could not hinder the exportation of gold and silver, which, on account of the smallness of their bulk in proportion to their value, could easily be smuggled abroad.*9 That this exportation could only be prevented by a proper attention to, what they called, the balance of trade.*10 That when the country exported to a greater value than it imported, a balance became due to it from foreign nations, which was necessarily paid to it in gold and silver, and thereby increased the quantity of those metals in the kingdom. But that when it imported to a greater value than it exported, a contrary balance became due to foreign nations, which was necessarily paid to them in the same manner, and thereby diminished that quantity. That in this case to prohibit the exportation of those metals could not prevent it, but only, by making it more dangerous, render it more expensive. That the exchange was thereby turned more against the country which owed the balance than it otherwise might have been; the merchant who purchased a bill upon the foreign country being obliged to pay the banker who sold it, not only for the natural risk, trouble, and expence of sending the money thither, but for the extraordinary risk arising from the prohibition. But that the more the exchange was against any country, the more the balance of trade became necessarily against it; the money of that country becoming necessarily of so much less value in comparison with that of the country to which the balance was due. That if the exchange between England and Holland, for example, was five per cent. against England, it would require a hundred and five ounces of silver in England to purchase a bill for a hundred ounces of silver in Holland: that a hundred and five ounces of silver in England, therefore, would be worth only a hundred ounces of silver in Holland, and would purchase only a proportionable quantity of Dutch goods; but that a hundred ounces of silver in Holland, on the contrary, would be worth a hundred and five ounces in England, and would purchase a proportionable quantity of English goods: that the English goods which were sold to Holland would be sold so much cheaper; and the Dutch goods which were sold to England so much dearer by the difference of the exchange; that the one would draw so much less Dutch money to England, and the other so much more English money to Holland, as this difference amounted to: and that the balance of trade, therefore, would necessarily be so much more against England, and would require a greater balance of gold and silver to be exported to Holland.”
One can substitute gold and silver for oil if one wants, however, I tend to think that it is more appropriate to use the “value of Land”. This implies that the pieces of wealth that are exchanged are in fact mortgages. According Smith, as long as the US's wealth is in its land then one can have a current account deficit (using modern terminology).
“No foreign war of great expence or duration could conveniently be carried on by the exportation of the rude produce of the soil. The expence of sending such a quantity of it to a foreign country as might purchase the pay and provisions of an army would be too great. Few countries produce much more rude produce than what is sufficient for the subsistence of their own inhabitants. To send abroad any great quantity of it, therefore, would be to send abroad a part of the necessary subsistence of the people. It is otherwise with the exportation of manufactures. The maintenance of the people employed in them is kept at home, and only the surplus part of their work is exported...”

Mortgages or more specifically mortgage-related securities held by foreign investors work. I personally connected/substituted the “value of Land” to that of Money/gold/sliver in order to make the following points:

• Chavez is taking advantage of the split in the US. A very good curve ball.


• Upward mobility has become stagnant:

“The exclusive privileges of corporations, statutes of apprenticeship,*78 and all those laws which restrain, in particular employments, the competition to a smaller number than might otherwise go into them, have the same tendency, though in a less degree. They are a sort of enlarged monopolies, and may frequently, for ages together, and in whole classes of employments, keep up the market price of particular commodities above the natural price, and maintain both the wages of the labour and the profits of the stock employed about them somewhat above their natural rate.“

The exclusivity of trade guilds (Monarchs) and the free wheel dealings of a capitalist society (monopolies) have the effect of stopping technological changes necessary to evolve a society. It is the lack of upward mobility that has allowed Chavez to pitch his curve ball. It is up to our so called elected officials to respond and prevent Chavez from pitching a shutout game.

“Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life.*1 But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man's own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities”

(A weak proof for the duality between Monarchs and a “pure” capitalistic society)

Land that is not used for production is land that does not need labors. The housing boom has, in effect, reduced the value of labor. Since labor determines the exchange value of all commodities, this reduction in labor usage has reduced the “Value of the Land”. In order to make up that value, with respect to the current account deficit, one must be a large land owner. In general, there is an “Aggregate Land Monopoly” (home owners). One can take the position that one should by a house. This is the problem. Home owners do not want to see their housing value go down. The housing affordability index limits new home buyers. If you are not a land owner then you are a labor. If you are a labor, your value has been decreased. This is true even for the most educated US citizen.

I admit that this is the extreme case. However, the CBO has released a report: The Role of Immigrantsin the U.S. Labor Market They did a nice job of not saying the obvious: Wages are in decline. I really don't care as to the reason wages are in decline, just the fact that they are. The outcome of the wage decline is apparent. Airlines can not meet their cost and auto makers can not charge the price they want.

One must take into account the diverges between housing prices and the affordability index. This can be explained by recognizing the fact that there is a supply and demand for mortgage-related securities. An example of this relationship is the following: Charles Swab offered Home Equity Line of Credit to homeowners whose houses were destroyed by Katrina. This action is irrational by a financial institution. They made the assumption that the value of the land would not decrease. This has place extraordinary on the insurance sector. There is an argument between homeowners and insurance companies as to “water damage” This argument is a sticking point and will place the US government in the position to rebuild the land in order to maintain its value.

There is a emotional desire to keep ones property even in the face of “having to reduce ones labor value” as long as financial institutions are willing to supply credit. I think Adam Smith would be appalled by the fact that so much wealth is being given to land that has no production (output).

In a very general way, one can almost make up the difference of the trade deficit by adding in securities. See F.210 Agency and GSE-backed Securities and Flow of Funds Matrix.

The global market will protect its investments through the process of greed and fear. The reaction of having the US government spending $60 billion on hurricane relief can be indicated by the dollar index. There was more of a knee-jerk reaction to the interruption of the latest fed minutes as toward a pause in rate hikes than there was to the spending of $60 billion and the possible cost of $200 billion.

Federal Reserve and Monetary Policy: Global Inflation Target

Morgan Stanley chief economist Stephen Roach is right in his view that Bernanke is going to have a problem with housing, however, he has missed his own solution. The basic problem with globalism is one of GDP equalization. It has been my opinion that there is a link between the trade deficit on government debt. Part of that link is the lack of income/tax revenue due to exporting raw materials to the US's factory floor in China and the increased in energy usage because India has become the back office for the US (the cost of the income/tax revenue gap is, to the first order, the trade deficit). India is not an economic crises. China is an economic crises.
The problem is Wall Street, which is the source Roach needs to acknowledge. He also has to acknowledge the problem also lies with Washington DC. One must recognize the fact that the US is playing the globalism game one way and other countries are playing the game another. The “Beltway” has to come to grips with the fact that the EU may shatter, Russia will not reduced its oil tax and China is pushing its sphere of influence into the oil rich Middle East (Iran and a sea port in Syria).

Only in America do the oil companies and other natural resource companies, own that resource. Countries like Russia own the oil and the oil company just acts as a “distribution” for that resource. The “Beltway” has to recognize that it is unlikely the “Globalism” will change this. Once the “Beltway” recognizes the nonequivalents of the application of “Globalism” rules then the solution to a housing bubble crises becomes apparent: remove Wall Street from the distribution of US tax dollars. In other words remove the repatriation of over seas profits (GE's TAX bill) and other tax breaks that has the same effect (tax breaks on mortgages interest payed, etc...). Not all tax breaks are equal. Take those taxes and push it into the local economy. Give multi-nations a tax break on overseas profits if and only if they reinvest it into creating US jobs. They do not get these tax breaks if they use it for stock buy backs and dividends. This will have the following effect; the US “Land Bank” retains its value because people can continue to pay their debts if these profits are plowed directly into the local economy of the US. If the multi-nations choose to keep their overseas profits overseas, then there is a probability that it will be invested in some of the cheap labor markets. This in turn will help these developing nations' GDP and hence accelerate the equalization of global GDP. If one looks at Scalar Multiplication of a Convolution in The Intensive Production Function and the Producer's matrix of Transition Probabilities section of my Neoclassical Theory of Production blog then one can gain an understanding how this is possible.

I know there are some who will differer on this, but Wall Street has become part of the global market. It is no longer the “center” of the universe. US multi-nationals created a monster when they decided it was ok to off-shore their back offices and move their manufacturing floor to China. They can no longer control their creation (you know the story of Frankenstein's Monster). Wall Street is in the way of globalization. Companies has merged, taken over, increased dividends and bought back stock, yet the equity market has not gained. This is their child's way of saying that they what their cash hoard to be invested to maintain global economic growth.

The only thing the Federal Reserve has to do is to try to make US interest rates competitive with respect to the rest of the globe. It is unlikely that they can make the flow of investments reverse from China and back into the US. In other words, the dollar will signal a neutral stance and the global financial markets will not place the dollar into crises because of a housing bubble popping. The global market has sent a clear signal due to the information of increased government spending after Katrina. Not all government spending is “evil”.

China is a black hole for investments and it is impossible to change this unless China changes its command economy. I know this and through the process of “greed and fear” the global market will come to the same strategy. If there is a current account deficit melt down it will be due to the current tax policy.

I believe that there is a GDP equalization in progress. It therefore makes Bernanke's theory to have a target for inflation, but this target is for the global markets. (Inflation Target => Increase in Global GDP).