Cognitive Biases Used in Propaganda Framing Deficit Debate and Wall Street Handout

Everyone likes to think that they are smarter than the average person. After all, how many of us would be ready to admit that they were in some way, shape or form inferior. Even those friends of ours from high school, and most of us who did not attend private boarding schools know these people, who accorded themselves “street smarts” while telling others that they were merely “book smart,” claim to be better at some things than the average. We all want to feel that we are good at something and even if this is not necessarily the case, we hold on to the illusion that we are somehow more skilled than the average Joe or Jane. Let us call this concept overconfidence.

In the academic literature it is called the overconfidence bias. Cognitive and behavioral psychology as well as behavioral finance and behavioral economics study the concept at length and in depth. Classic examples include asking everyone in a class to rate their driving ability as average, below average or above average. In study after study between 80 and 90 percent of respondents rate their driving ability as above average, which cannot be the case, since only slightly less than half can be above average. Other studies have repeatedly shown that when asked to rate our confidence interval in our statements, we are much more likely to state a much higher confidence level than our accuracy. Most of us like to think that we are smarter than the average, and do not wish to accept that, truthfully, we are probably by definition just about average in many of those attributes that are indeed normally distributed. Some of us might be better at some things than others, obviously, but we are not as superior as we would like to think. Nonetheless, this feeling of being superior, this confidence in our abilities, this sense that we will do better than most everyone else can lead us to take risks we normally would eschew, were it not for the nagging near-certainty that we are better, smarter and more insightful than the others, and that this time, for us, contrary to all evidence and history, things truly will be different, be it in business, investment, games or any other of the myriad activities we engage in where we are in it to win it. Think of housing and stock market bubbles, when real estate speculators and traders or money managers no doubt thought that they would be able to time the market and get rich quickly because of their superior skills and knowledge.  

Standardized testing reinforces this bias by inflating the egos of those whose scores are in the upper percentiles. These are the people who get accepted to the best universities, who go on to graduate school because they had GMAT or GRE tutoring classes, and some of these people think that they are the true producers and “value creators” of society, deserving six or seven or eight figure remuneration because of their superior natural or god-given abilities. Everyone else who is not as successful is either morally deficient or intellectually limited and their plight or poverty is therefore deserved and just.

The fundamental attribution error states that the successes of one’s group, class, clan, or tribe, generally called the in-group, are due to internal factors, such as talents, morality, hard work and intelligence, while failures are due to external, uncontrollable causes; with the mirror image being perceived as the reasons for the failures of the out-group, the others: inferior intelligence, lack of talents, or simply laziness, and with the out-group’s successes being consequently simply a matter of luck and often undeserved. So the fundamental attribution error is to attribute success to internal and failure to external factors for oneself or one’s in-group, and the opposite for those in the out-group.

Nowhere is this phenomena more prevalent and on display than in the United States of America, where the current culture war is further being waged on behalf of the top 1%, or was it 0.1%, or 0.01%, who not only receive most of the income but also own most of the wealth in the country. The current battle about “unsustainable” government spending, government needing to live within its means, and ever-present deficit reduction hysteria, is nothing more than an ideological battle being waged by those with means who believe that they should not have to pay any money for those without means, whom they consider shiftless bums and welfare queens who refuse to work and expect “handouts” from the government. Whatever the percentage of poor who do abuse the system, however large, small or inconsequential it might actually be, this discussion is not about them, it is only being framed in this manner. Framing effects arise when different responses are elicited based on whether the information is presented in a positive or a negative frame. Is the man or woman in dire straits because they were laid off due to downsizing, outsourcing, or company or business failure; or is the person unemployed because they are lazy and want free money from the government. By framing the narrative to portray the less well-off, the unemployed, and the poor in general in the latter manner, stereotypes are being created and reinforced. This is a further cognitive bias at work, the representativeness heuristic, which asks to what extent does A represent B, so to what extend do the poor and unemployed represent my stereotypical image of them. The representativeness bias is thought to be an innate and omnipresent trait, presumably brought about as a function of evolution. The manner in which it is being abused, though, is that through propaganda -- there is no other way to put it -- the unemployed are portrayed as lazy, shiftless, and not wanting to work, but expecting handouts and being able to sit at home drinking or drugging on the taxpayer’s dime. If you work and pay taxes, you are being led to believe that your money is not being spent on military armaments so that the US military can continue blowing up brown people somewhere to make the area safe for liberal capitalism and Halliburton and Bechtel; or that your money is going to bail-out Wall Street; rather, the public is told that taxpayers’ money is going to pay for the immoral and lazy who do not want to work. It is forgotten that the financial system brought about a collapse of the economy bringing along the unemployment that comes with recession and depression. But by reiterating this narrative that the poor and unproductive are unjustly taking money from the rich and productive, powerful interests serving right wing wealth -- see Rupert Murdoch and Roger Ailes along with the Koch brothers, for example -- are framing the discussion to serve their interests, which are to roll back any and all social programs since the New Deal and the Great Society, to take us back to a time when capital was king and the government did not dare tax the hard earned millions or billions of robber barons, when workers knew their place, and corporations would be unhindered in their pursuit of the bottom line, the environment, and the public be damned. Some might say we are already there.

Besides always having been a right wing ideological dream, one could call it Milton Friedman’s “wet dream”, to demolish the social welfare state, to “drown it in a bathtub” as per Grover Norquist`s wishes, currently the unemployed, unions public or private, those on welfare, and all those whose lifetime of work and paying into a system of social security in the expectation of receiving benefits when they retire have seen any government program suddenly become “unsustainable entitlements.” In unison the scream is: “We must cut all social programs or we will go bankrupt,” some louder than others, but all of them singing the same song: the Tea Party, the Republicans, some Democrats, and the President himself, at first unbelievably and unfortunately, but currently obviously and to be expected now that it has become perfectly clear that Obama stands to the right of most civilized conservatives on many issues.

The most insidious lie, however, is not only that the US is going broke because of social welfare programs, but that the US government can go bankrupt at all, after the surreal demonstration of money creation to hand over to an insolvent financial system and their investors and creditors. If one looks at the fact that a sovereign government which is in charge of its own currency can never go bankrupt, something that has long been explained and propounded by Professor L. Randall Wray, Marshall Auerback, Professor Bill Mitchell, Warren Mosler, and many others who understand modern monetary theory; and stunningly admitted by none other than “Helicopter Ben” Bernanke himself, who did indeed drop staggering amounts of money into the laps of the financial sector; and if one finds out from the report of the Special Inspector General of the Troubled Asset Relief Program (SIGTARP report here) presented to Congress by Neil Barofsky, who was in charge of SIGTARP, that up to $23.7 TRILLION were created in guarantees, equity injections, and toxic asset purchases, along with an extensive alphabet soup of programs ostensibly created to bring the US economy back from the brink of Depression and financial Armageddon, then any talk of budget constraint and the US running out of money is ridiculous and disingenuous.

The TARP; regulatory forbearance, which simply means that we will forget a while about bankruptcy rules which state that when you go bankrupt you are out of business, management gets fired and your assets get liquidated to pay your creditors; along with changes in mark-to-market accounting rules which allowed many to get obscenely rich during the bubble years but are now allowing insolvent institutions to hold worthless assets on their balance sheet at inflated prices, further kicking the can down the road in an exercise of extend and pretend; and letting the banking system finance itself at interest rates at 0.25%, money which is then promptly lent back to the government at several percentage points higher, might just strike informed observers as being simply gifts not only to the executives of too-big-to-fail banks for doing such a fantastic job of running their companies into the ground and helping the US economy come to the verge of Depression, but also a bailout of these companies’ bondholders and shareholders, since risk in finance was just a joke, and does not really exist due to the “Bernanke and Uncle Sam put”. “Profits are privatized and losses are socialized,” and everyone should read Yves Smith for her unmatched analysis of the events of the past years.

Once one realizes that for the US government money can simply be created and does not need to be borrowed, and that of the trillions that were created much was simply given away to the US banking and finance sectors and their bondholders, shareholders and creditors, which incidentally also bailed out a lot of foreign banks, then one might realize two things: that free market capitalism no longer exists, if it ever did anyway, when the government selectively chooses whom to rescue and how much money to give away, and that it is not the unemployed, sick and poor who have brought the country to the brink of ruin, but rather an extractive and predatory financial system that has co-opted the government to cater to its needs and not to those of the people. There is a reason it is called “Government Sachs”.

Because people are easily manipulated and susceptible to cognitive and behavioral biases, and because they have a short attention span and are more concerned with celebrity gossip than their own lives, not realizing that they are giving away their life energy to illusions created to keep them docile and distracted, highway robberies and sleight-of-hand such as TARP et. al. can brazenly be pulled and the biggest robbery in history does not concern citizens whose governments now have any protesters beaten bloody by riot police with batons and teargas. It is “bread and circuses” as it has been for most of human history. But when either the “bread” or the “circus” are missing, then people are forced to think about their own existence and maybe, just maybe, see through the corporatist fascist propaganda and wake up enough to become informed, indignant, independent and irrepressible.  

ECONNED -– The Movie, Um, Video!

Awsome video from Yves Smith!

ECONNED – The Movie, Um, Video!
A very talented movie/commerical/trailer editor, who for some bizarre reason insists on going nameless (but if you want his coordinates, don’t hesitate to ping me) assisted by Ben Fisher in a major role (finding images and video clips) and Richard Smith in a minor role (extensive sanity checking) put this together.

This may inspire McLuhan-esque debates, since I wanted something true to the medium, as in visceral and immediate, rather than the usual talking head sort of piece.

Enjoy! Oh, and turn the sound up

Buy this book! Econned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism

Make sure you get the upcoming book from my friend Yves Smith of www.nakedcapitalism.com fame.

Countdown 3/2/10: Excerpt from Econned
Folks, the time has come when I must start shamelessly promoting my book, Econned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism, which is being released March 2, 2010.

I thought the extract below would give readers an idea of what the book is about, with one caveat. Econned goes into some detail about crisis mechanisms (as in why it got as bad as it did) and has unearthed a heretofore unexamined hedge fund trading strategy that turned the subprime mania into the detonator of the global debt bomb (and yes, we have the goods).

Enjoy!

In 1776, Adam Smith published The Wealth of Nations. In it, he argued that the uncoordinated actions of large numbers of individuals, each acting out of self-interest, sometimes produced, as if by “an invisible hand,” results that were beneficial to broader society. Smith also pointed out that self-interested actions frequently led to injustice or even ruin. He fiercely criticized both how employers colluded with each other to keep wages low, as well as the “savage injustice” that European mercantilist interests had “commit[ted] with impunity” in colonies in Asia and the Americas.

Smith’s ideas were cherry-picked and turned into a simplistic ideology that now dominates university economics departments. This theory proclaims that the “invisible hand” ensures that economic self-interest will always lead to the best outcomes imaginable. It follows that any restrictions on the profit-seeking activities of individuals and corporations interfere with this invisible hand, and therefore are “inefficient” and nonsensical.

According to this line of thinking, individuals have perfect knowledge both of what they want and of everything happening in the world at large, and so they pass their lives making intelligent decisions. Prices may change in ways that appear random, but this randomness follows predictable, unchanging rules and is never violently chaotic. It is therefore possible for corporations to use clever techniques and systems to reduce or even eliminate the risks associated with their business. The result is a stable, productive economy that represents the apex of civilization.

This heartwarming picture airbrushes out nearly all of the real business world. Yet uncritical allegiance to these precepts over the last thirty years has produced a world in which corporations, especially in finance, are far less restricted in their pursuit of profit. We show in this book how this lawless environment has led the financial services industry to pursue its own unenlightened
self-interest. The industry has become systematically predatory. Employees of industry firms have not confined their predation to outsiders; their efforts to loot their own firms nearly destroyed the industry and the entire global economy. Similarly destructive behavior by other players, often viewed through a distorted lens that saw all unconstrained commercial behavior as virtuous, added more
fuel to the conflagration.

Some economists have opposed this prevailing ideology; indeed, comparatively new lines of inquiry focus explicitly on how economic actors can fool themselves or others into making poor, even destructive, choices.

But when the economics profession has used the megaphone of its authority to dominate discussions with policymakers and the public, it has spoken with one voice, and the message has been the one described here. We therefore confine our criticism to these particularly influential ideas.

Theories that fly in the face of reality often need to excise inconvenient phenomena, and mainstream economics is no exception. Idealizing the rational aspects of business decisions means refusing to notice behavior that is predatory, destructive, criminal, or simply stupid. Believing that risk is manageable through mechanical systems has required not just unrealistic assumptions but also willful
blindness to clear signs of danger.

We offer here another point of view. This book lays bare both the actions leading to the credit crisis and the economic constructs that defended, facilitated, and even exacerbated this behavior. Our case makes clear that if our economic system is to harness the self-interest of individuals to achieve the general
good, it must be supervised within a democratic society and responsive to criticism by outside voices of those who are unafraid to think independently.

Reflexivity in Action

Reflexivity in action. That is all.

The Precondition for an Economic Recovery According to Keynes and Confirmed by, of all People, Greenspan

Most of the blogosphere has been skeptical of the rally in equities since the beginning, with ZeroHedge pointing out that the rise can be attributed, basically, to free money courtesy of the Federal Reserve, and aided and abetted by High Frequency Trading and the principal program trading of the usual suspects. Now, even for those who are not conspiracy minded, charts such as these speak volumes(pun intended).

From ZeroHedge.

I would like to point out one possible explanation for this phenomenon from a contentious source that I have quoted before. I maintian that Keynes is misunderstoond by many and that he is not the source of all wisdom, but, rather, someone who asked the right questions at the right time and pointed out many problems in the workings of the economy in periods of turmoil.

Unfortunately a serious fall in the marginal efficiency of capital also tends to affect adversely the propensity to consume. For it involves a severe decline in the market value of Stock Exchange equities. Now, on the class who take an active interest in their Stock Exchange investments, especially if they are employing borrowed funds, this naturally exerts a very depressing influence. These people are, perhaps, even more influenced in their readiness to spend by rises and falls in the value of their investments than by the state of their incomes. With a "stock-minded" public as in the United States to-day, a rising stock-market may be an almost essential condition of a satisfactory propensity to consume; and this circumstance, generally overlooked until lately, obviously serves to aggravate still further the depressing effect of a decline in the marginal efficiency of capital.
When once the recovery has been started, the manner in which it feeds on itself and cumulates is obvious. But during the downward phase, when both fixed capital and stocks of materials are for the time being redundant and working-capital is being reduced, the schedule of the marginal efficiency of capital may fall so low that it can scarcely be corrected, so as to secure a satisfactory rate of new investment, by any practicable reduction in the rate of interest. Thus with markets organised and influenced as they are at present, the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest. Moreover, the corresponding movements in the stock-market may, as we have seen above, depress the propensity to consume just when it is most needed. In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.

The point of contention is, and has been, the last sentence, which raises the blood pressure of everyone involved, on both sides, like nothing else ever written about economics (save maybe Marx). I am not venturing out on a limb when I say that the powers that be have read this passage and drawn their own conclusions from it. Even Greenspan said :

The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged

.
Juxtaposing these two quotes does not a proof of a government engineered market melt-up make, but one does have to wonder.

Steve Keen on the economy: On the Edge with Max Keiser

Steve Keen is one of the few economists who predicted the financial crisis and he is not at all impressed with the government response arguing that texboox economics failed to predict the crisis and are also not going to solve the problems we are facing. His outlook is less than rosy to say the least.

Dilbert on the economy

How much should we fear the "L" shaped economic recovery?

Paul Willmott has an interesting blog post in which he said that he is hoping for one L of a recovery and I have to say I concur wholeheartedly. The economic prognosticators , after peering into their respective crystal balls or tea leaves, have seen the future and declared it a V , U , W, square root and other exotic shapes. Now almost all observers are in agreement that the dreaded L shape which plagued Japan is to be avoided like the pest. Not so Wilmott, the whiz of quantitative finance. He asks:

"Have you any experience of Japan in the 1990s? Well I have. And it didn't seem too bad to me. Were there hordes of people begging on the subway? Not that I recall. Was it dangerous roaming the streets for fear of being mugged? No, it seemed safe enough when I was there. Was there high unemployment and general desititution? No. More on this anon.

Japan in the 1990s was, as it still is, a safe, enjoyable place, with a very high standard of living, and at the cutting edge technology wise. Not the hell hole that economists like to paint. And so I really cannot imagine what Japan would be like now if they'd had a V-shaped recovery. They'd all be communicating by telepathy and travelling via matter transporter I guess.

To me the important point about the economy is not what letter of the alphabet best represents it, nor its percentage growth. After all, is it really necessary to grow at x percent per annum in order to maintain the feeling of status quo? Like the shark, which supposedly has to keep moving forward in order to stay alive. What sort of life is that? I believe what is most important is the well being of the people, and that's not the same as GDP. It is, however, closely linked to rate of employment. And that's where Japan does remarkably well. That's what governments should focus on, to L with growth!"

This flies in the face of the conventional economic wisdom which repeats the words growth and consumption in a manner resembling autism, someting duly noted by the post-autistic economics network .

And for what ultimate purpose do we need this constant economic growth? To continue to live according to Victor Lebow´s encomium of consumption ?

"Our enormously productive economy demands that we make consumption our way of life, that we convert the buying and use of goods into rituals, that we seek our spiritual satisfactions, our ego satisfactions, in consumption. The measure of social status, of social acceptance, of prestige, is now to be found in our consumptive patterns. The very meaning and significance of our lives today expressed in consumptive terms. The greater the pressures upon the individual to conform to safe and accepted social standards, the more does he tend to express his aspirations and his individuality in terms of what he wears, drives, eats- his home, his car, his pattern of food serving, his hobbies.
These commodities and services must be offered to the consumer with a special urgency. We require not only “forced draft” consumption, but “expensive” consumption as well. We need things consumed, burned up, worn out, replaced, and discarded at an ever increasing pace. We need to have people eat, drink, dress, ride, live, with ever more complicated and, therefore, constantly more expensive consumption."

I would prefer instead to turn to Keynes:

"The full employment policy by means of investment is only one particular application of an intellectual theorem. You can produce the result as well by consuming more or working less. Personally I regard the investment policy as first aid… Less work is the ultimate solution.”

Much more on this topic can be found here at econospeak.

A Non-Normal Recovery

In my previous post I made the contention that we should not expect a robust recovery and that there was the risk of a "W" shaped double dip. Lets see what the consensus is and whether this is a normal recession as some "green shooters" claim, or something else entirely that no one really wants to acknowledge.



From macroblog, the source of the chart.

The chart plots the four-quarter growth rate of gross domestic product (GDP) from the trough of a recession against the depth of the corresponding contraction, as measured by the cumulative loss of GDP over the course of the downturn. The points within the red circle represent all previous postwar recessions, and they form a nice, neat, easily discernible pattern. That is, the pace of growth in the first year after a recession has, in our history, been reliably related to how bad the recession was. The deeper the recession, the faster the recovery.

The points within the blue circle are based on forecasts of GDP growth from the third quarter of this year through the third quarter of 2010, obtained from the latest issue of Blue Chip Economic Indicators (which reports survey results from "America's leading business economists"). From top left of the circle to bottom right, the points represent the 10 lowest forecasts of the most optimistic members of the 50 Blue Chip forecasting panel, the panel's consensus (or average) forecast, and the 10 highest forecasts of the most pessimistic panel participants.

I chose the third quarter as the reference point because nearly two-thirds of the Blue Chip respondents indicate that, in their view, the recession will indeed end in the third quarter of this year. Assuming this occurs, this recovery would appear to be a big outlier. Either we are about to continue making history—and not in a good way—or current guesses about the medium-term economy are way too pessimistic.

On another note, if you would like to do a little prognosticating of your own, I commend to you our new weekly editions of Economic Highlights and Financial Highlights.

By David Altig, senior vice president and research director at the Atlanta Fed

Well, if the consensus is that the recovery will be absolutely anemic, judging by these low prognostications, then perhaps the "this is a normal recession" meme form the MSM should be dropped because it is incompatible with the consensus forecasts. But we would not want to scare anyone with more truthful reporting, would we? As it turns out, judging by todays consumer confidence index , the US consumer has become cognizant that if one has no job, then there is little reason to rejoice and go on a shopping spree once again in order to jumpstart that 70% of the US economy that depends on consumer spending.

Outlook for Inflation

As always in such debates there is no consensus to be found as to whether the prices will rise or fall in the foreseeable future in the USA. On the one hand, inflation hawks see a Weimar-esque hyperinflationary financial armageddon brought about by what they consider to be profligate government spending and a complicit central bank providing massive liquidity and engaging in „quantitative easing“ all of which, for inflation hawks, is by definition inflationary. The dramatic increase in the monetary base (see Exhibit 1) has led some commentators to predict rapidly rising inflation and high interest rates (Laffer 2009, SeekingAlpha 2009), firmly following Milton Friedman´s mantra that inflation is always and everywhere a monetary phenomenon (Meltzer 2009). But even such a stalwart conservative economist as Mr Laffer admits in his Wall Street Journal piece that the velocity of circulation is important and that banks will eventually lend enough to become reserve constrained again "given enough time."



David Altig, the vice president of the Atlanta Fed, takes issue with Laffer´s claims and points out that bank lending has actually decreased while the monetary base has increased (see Exhibit 2).



This means that money sitting in banks as excess reserves is not in itself inflationary (Thoma 2009) and since the velocity of circulation has dropped (see Exhibit 3 for an historical view) and there is no evidence that consumers or businesses are becoming more rather than less credit worthy, banks have consequently not increased their lending.




Krugman (2009) draws paralles to the liquidity traps faced by Japan in the 1990´s and the US in the 1930´s (see Exhibit 4).





As pointed out by Hoisington and Hunt (2009) only 1.9% of the increase in reserves was available for lending and bank loans fell an annualized 5.4% from December to March. They add that the velocity of circulation of money can be thought of conceptually as being related to leverage and financial innovation. Needless to say, the world has had its fill of financial innovation for some time and currently deleveraging is a pervasive and prevalent phenomenon. The Fed would like nothing better than to increase the velocity of the circulation of money but since it is unable to, for the reasons outlined below, fears of inflation are misplaced and threaten to prevent a robust recovery and lead to a W shaped double dip or worse.

Those who foresee a deflationary spiral point out that the overleveraged US consumer who has seen a massive drop in the value of assets and is facing rapidly rising unemployment will not be able to spend enough to prop up the economy. There would need to be multiple shifts in the aggregate demand curve and with unemployment rampant wages would seriously lag inflation (Hoisington and Hunt 2009). Moreover, unemployed people tend to spend less money, and people who feel poorer because of the drop in their portfolio, IRA, 401k, and house price are also unlikely to spend enough to cause much inflation. That is, asset price deflation can lead to a debt deflation spiral which interacts with the Keynesian paradox of thrift, along with cost cutting deflation and, as pointed out above, the contraction of bank credit, all of which are individually managable, but together a lethal combination (De Grauwe 2009).


To me, the latter view is much more plausible since inflation is not some bogy out to get us lurking in the shadows, but the succesful passing on of price increases by producers to consumers. On June 16, 2009, amid a slew of terribly economic data, Bloomberg.com reported that wholesale prices dropped 5 percent in the past year and that producer prices ex food and energy dropped 0.1 percent in May. Cost-push factors such as an increase in the price of inputs, for example oil, would not be immidiately passed off to consumers who are purchasing less anyway at lower prices. This all but precludes demand-pull factors triggering inflation, since people have to be willing to pay more for certain goods. In order for this latter to occur, consumers have to be willing and able to spend. The US consumer is overleveraged and has maxed out credit cards, which has led to default rates at credit card companies that are more than the unemployment rate (ZeroHedge 2009).

The precipitous drop in property prices and rise in unemployment
(see Exhibit 5 for unemployment data from Calculated Risk) are not going to lead to any inflation.



The implied expectations of inflation in long term treasury bond funds reflect constant expectations (see Exhibit 6, Young 2009).



Moreover, even if demand for commodities, especially oil, increases, then there will still need to be a somewhat positive overall sentiment and, actually, dollar weakness, since, when „bearish“ sentiment predominates, then, in a „flight to safety“ investors paradoxically jump into the currency they love to hate, the dollar, whose appreciation will offset the effect of increased demand for commodities on their price. Furthermore, the last oil bubble was undoubtedly fueled by speculation, and, in my humble opinion, so has the current rally in commodities. Aluminum is a prime example of how the price of a commodity can defy supply and demand.

I do not subscribe to the monetarist doctrine that liquidity is per se inflationary. If no one is spending the money, that is, the velocity of circulation is very low, then there will also not be much of a general increase in prices. It should not be forgotten that world demand and consequently economic performance have dropped off a cliff (Eichengreen and O´Rourke 2009) and that because of rising unemployment and the debt and savings dynamics mentioned above we will not return „to happy days again“ anytime soon. What I mean is that the halcyon days of five or ten years ago of rapidly rising asset prices and moderate CPI increases when everyone felt richer and consequently fed huge increases in the value of assets are gone. The US consumer has started to save after decades of living beyond his means but is still faced with a mountain of debt and low or stagnating wages (see Exhibit 6 from sudden debt).



I do not think that much of an economic recovery is going to take place this year and that for the reasons outlined above inflation will not be a problem in the near future.

Of course, I did say „near future.“ To keep inflation in check once a real recovery does set in will take aggressive and, one would hope, enlightened policy responses. Prevention of another massive asset bubble would also help, but this is unlikely. In his book „A Short History of Financial Euphoria“ (1994) John Kenneth Galbraith said that the financial memory lasts about 20 years, until a new generation of wheelers and dealers will fuel the next asset bubble and assure everyone that this time it is different and asset prices can, indeed and contrary to all historical evidence, rise indefinetly.