Krugman Perpetuates Myth of the Zero Lower Bound

Professor Paul Krugman

Professor Krugman just published a column where he deserves kudos for sticking his neck on the line and predicting that the Bernanke Fed is not creating a bubble in bonds, and "probably not" in stocks either.

While the argument on whether or not Bernanke is blowing bubbles is interesting and worthy of discussion (although only time will tell for sure), that's not what this post is about.

In the column Krugman makes a somewhat tangential comment about what economists often refer to as the 'zero lower bound problem' on where a central bank can set interest rates. Here's Krugman's quote:

"True, it (the Fed) can’t cut rates any further because they’re already near zero and can’t go lower. (Otherwise investors would just sit on cash.)"

Krugman's statement is problematic for several reasons:

First, it's misleading and patently false of Dr. K to say that the Fed "can’t cut rates any further" when in fact it can. There is no economic or natural law which prevents the Fed from setting nominal rates at exactly zero, or at a negative rate.

Whether they should be set at zero or negative is another question. In short, Dr. K needs to replace "can't" with something like "could but shouldn't because...".

Second, I suggest that it would be helpful if Dr. K was a little more precise so that people understand why the Fed "can't" (shouldn't) set zero or negative rates but Denmark's central bank can set a negative deposit rate, and now Drahgi at the ECB is openly discussing this as well.

To be clear, I'm not endorsing negative rates. I'm only saying that negative rates are possible and that some central banks are experimenting with negative rates as a policy tool.

And finally, yes, perhaps if the Fed were the only central bank to pursue a negative rate policy then investors may sit on cash, move their money elsewhere, etc. But if enough central banks around the world kept driving rates further and further into negative territory then it would be very surprising if this didn't help generate inflation, in which case people would probably not be sitting on cash as Dr. K suggests but rather spending it before money lost its purchasing power.

The long perpetuated myth of the zero lower bound is starting to be challenged more and more, and for a more detailed academic discussion of the zero lower bound myth see here. 

Interactive Global Debt Clock

Courtesy of The Economist

The clock is ticking. Every second, it seems, someone in the world takes on more debt. The idea of a debt clock for an individual nation is familiar to anyone who has been to Times Square in New York, where the American public shortfall is revealed. Our clock shows the global figure for all (or almost all) government debts in dollar terms. 

Does it matter? After all, world governments owe the money to their own citizens, not to the Martians. But the rising total is important for two reasons. First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future. Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments, rather as reality TV show contestants face a public phone vote every week. Fail that vote, as the Greek government did in early 2010, and the country can be plunged into imminent crisis. So the higher the global government debt total, the greater the risk of fiscal crisis, and the bigger the economic impact such crises will have.

h/t zerohedge

Bill Gross Harps on Financial Repression

Picking up right where he left off last month, the Bond King's latest letter sounds-off on how financial repression is a bad deal for U.S. treasury investors.

Video: Financial Repression Coming to America?

Visit msnbc.com for breaking news, world news, and news about the economy

Video: U.S. State Budgets - Day of Reckoning Upon Us

Of Bonds, Bubbles, and the "Sean Connery of Bonds"

The ultimate Bond

James Bond aficionados interested in a guide to the world of bonds (government, investment grade, emerging markets, etc.) will enjoy this cheeky video from the FT.

In the video various categories of bond investments are compared to the main actors to don the role of 007 -- Roger Moore, Pierce Brosnan, Daniel Craig, and of course the original HMSS agent, Sean Connery.

Who was your favorite actor to play James Bond?

Bill Gross: Run Turkey, Run

Bill Gross, PIMCO

A must read from the 'Bond King' which covers:

• Next Wed's Quantitative Easing II (QE2), which instead of labeling as 'printing money' Gross refers to as 'writing checks'
• The U.S.'s broken political system and his recommendation on what to do about it
• What investors can expect going forward

Today's Feast for Bears

Stock market bears were handed ample fodder today:

• Comments from Nobel Prize winning economist Joseph Stiglitz on how Europe is at risk of a "double dip" recession due to ill-timed government budget cuts. Professor Stiglitz  has been supposedly advising Greek officials nearly every day since their debt crisis erupted this spring -- ignore this insider's words at your own risk.
• The safe haven Japanese yen rallied to a 15-year high versus the U.S. dollar at 83.59, well beyond the psychologically important 85 level. The yen also hit a nine-year high versus the euro at 105.43. If the yen appreciates further towards 80 vs. the Dollar, the Bank of Japan will probably be forced to intervene with or (more likely) without G7 coordinated action. 
• While the yen is rallying the Japanese stocks are in a bear market, with the Nikkei down over 20% and under the psychologically important 9,000 level.
• Another safe haven currency, the Swiss franc, just rallied to an all-time high against the euro at 1.30 as once again it appears money is flowing out of the EU and into Switzerland.
• Unless you've been hiding under a rock today -- understandable if you've got a lot of equity tied up in the value of your home -- you probably already saw that July home sales figures were abysmal and indicate room for a much further decline in housing prices. Further significant declines in housing -- some estimating another 10-30% down -- may trigger a significant increase in strategic defaults.
• Money continues to pour into bonds as the yield on the U.S. 10-year note punched all the way up to 2.47%, the lowest level since the stock market was pricing in financial armageddon in March 2009.

What does this all mean?

Is the Fed About to Go Nuclear?

"We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system and for the global economy. Think the unthinkable." 

- Andrew Roberts, Credit Chief, Royal Bank of Scotland (RBS)

(Note: this article is aimed in particular at individuals that are not as familiar with concepts such as quantitative easing, inflation, deflation, and what all this talk of 'printing money' means. These concepts can appear complex and intimidating, but they are not beyond reach of non-economists. Further, they are incredibly important to everyone. My hope is that you will take the time to learn more about this important topic and click through to some of the background info links I have included.)

The latest installments from the Telegraph's Ambrose Evans-Pritchard, who has been dutifully chronicling and predicting quite accurately the unfolding global financial crisis, suggest the U.S. Federal Reserve may be about to double down on its massive money printing campaign.