Chart of the Day: The Laffer Spike

posted at 10:11 am on June 11, 2009 by Ed Morrissey

Arthur Laffer, who brought us the Laffer Curve in the 1980s, has another kind of geometric shape for us today in the Wall Street Journal.  Let’s call it the Laffer Spike, and unfortunately this one isn’t hypothetical.  It demonstrates the massive boost in monetary supply pushed by the Fed and the government, and its historical singularity (via QandO):

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

About eight months ago, starting in early September 2008, the Bernanke Fed did an abrupt about-face and radically increased the monetary base — which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash — by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.

The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base — which prior to the expansion had comprised 95% of the monetary base — has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!

Laffer says we don’t have a historical model for this kind of action, and cannot accurately predict its effects.  That’s not entirely true.  While the US has never done this before, we do have at least one historical parallel from the 20th century: the Weimar Republic government of Germany that preceded the Nazis.  In fact, they deliberately printed money and devalued their currency in order to pay off (in worthless currency, but at face value) the crushing national debt imposed on them by the Treaty of Versailles.

Some have suggested that the US will have to follow the same model to rid itself of the massive debt we’re incurring now, which makes investors much less enthusiastic about Treasuries.  We’ve already begun to see the effects of this policy on the bond markets, with investors demanding higher yields as a hedge against the runaway inflation of this model.  The Financial Times reports that the US had to push yields up to 4% to get buyers this week, and they expect more trouble in today’s auction:

US long-term interest rates rose to the highest level of the year on Wednesday, threatening the “green shoots” of recovery, after the latest sale of 10-year government debt met with a tepid response from inflation-wary investors.

Concerns about the growth of government borrowing forced the US Treasury to give investors in an auction of $19bn in 10-year notes a yield of 3.99 per cent – 4 basis points higher than the yield available before the auction. That constituted the biggest yield markup since a 10-year auction in May 2003, said Morgan Stanley. Yields on the 10-year note, the benchmark rate for US mortgages, hit a high of 4 per cent during the day, up from 3.6 per cent a week ago. …

The next test of the US Treasury’s issuance program looms on Thursday with the sale of $11bn in 30-year bonds. An auction of 30-year bonds last month went badly as investors signalled their concerns about the budget deficit.

“That did not go well last time, so there is also some additional concern,” said Dominic Konstam, head of interest rate strategy at Credit Suisse.

If we have to keep paying higher interest rates for the Treasuries, we’re going to see much bigger deficits in the coming years than either the White House or the CBO projected earlier, as our debt service will skyrocket:

Unless we cut spending now, we’ll be setting up an inflationary ride like nothing we’ve seen before.


Related Posts:

Breaking on Hot Air

Blowback

Note from Hot Air management: This section is for comments from Hot Air's community of registered readers. Please don't assume that Hot Air management agrees with or otherwise endorses any particular comment just because we let it stand. A reminder: Anyone who fails to comply with our terms of use may lose their posting privilege.

Trackbacks/Pings

Trackback URL

Comments

Comment pages: 1 2 3

Tacitus SGL: there is indeed a linear relationship between growth in M0 and in M1-3. M0 is a subset of M1, M1 is a subset of M2, etc. But M1-3 are orders of magnitude larger than M0, which is why a 100% increase in M0 results in only an 8.5% increase in M2. I don’t think they report M3 anymore, so I don’t know what those numbers are, but it would be proportionally less.

This explanation makes sense. Could it also be, then, that the spike on Laffer’s chart has been driven mostly over the past two hundred days and thus the effects on M1-3 will lag until that currency in circulation has had a chance to work its way through checkable deposits and savings deposits in our banking system?

Just to be clear, I’m asking if you think it’s possible that M1 & M2 could be lagging since the increase in M0 has happened so recently?

Tacitus_SGL on June 11, 2009 at 5:29 PM

The only solution is for private citizens to begin hoarding and burning money to keep supply down.

Any volunteers?

Aronne on June 11, 2009 at 5:45 PM

The only solution is for private citizens to begin hoarding and burning money to keep supply down.

Any volunteers?

Aronne on June 11, 2009 at 5:45 PM

The only solution? wow big thinker/s

CWforFreedom on June 11, 2009 at 6:23 PM

Tacitus SGL: an interesting question, and one that, frankly, I don’t know the answer to. Looking at the data from the Fed, there doesn’t appear to be any lag time, but that could just be because other factors dominate the effect of an increase in M0 to such an extent that the timing effects are lost in all the other “noise”.

In which case, of course, Laffer may be inferring a cause-and-effect relationship that does not actually exist.

HTL on June 11, 2009 at 6:40 PM

Can I have fries with that??

DamnYankee on June 11, 2009 at 10:40 AM

Remedial assignment for you, DY, watch the video again!

Fearless Leader clearly says “You want fries?” before leaving for Five Guys.

Get in step!

VekTor on June 11, 2009 at 7:08 PM

I can balance a bowl in my head. I’m good to go.

SouthernGent on June 11, 2009 at 10:25 AM

There are millions of things I can do in my head. The test comes when you have to do it in real life…

VekTor on June 11, 2009 at 7:11 PM

The only solution is for private citizens to begin hoarding and burning money to keep supply down.

Any volunteers?

Aronne on June 11, 2009 at 5:45 PM

Do we get to pick and choose whose money it is that’s going to be hoarded and then burned?

VekTor on June 11, 2009 at 7:12 PM

cool!

moonbatkiller on June 11, 2009 at 7:32 PM

I am so angry I think my head is going to spin. I come here so I know there are others like me.

constitutionlady on June 11, 2009 at 8:06 PM

There is a bright side (of sorts) to all of this crap coming at us at light speed – The Obozo voters are gonna be hit first and hit HARD!
We’ll have about three weeks to laugh at them.

Lanceman on June 11, 2009 at 10:15 PM

As I stated earlier…

I agree,

“labels… are only applicable in a particular historical context…” or by further specific definition and refinement by those who espouse the particular religion or ideology. Geezer on June 11, 2009 at 10:08 AM

The National-Socialist Party and the German National (Conservative) Party ~ By Adolf Hitler (1922) Geezer on June 11, 2009 at 12:04 PM

“The radical of one century is the conservative of the next. The radical invents the views. When he has worn them out the conservative adopts them.” ~ Mark Twain-Notebook, 1898

I still remain your humble servant.

Be Jeebuss…I luv you gals and guys…!

Geezer on June 11, 2009 at 10:51 PM

I’m slightly frightened that there is only a short stint where the change in monetary flow is below zero… Doesn’t that mean the Fed is constantly pumping more money in than it is taking out?

Does this give anyone else reason to get rid of the Fed?

ConservadorRebelde on June 12, 2009 at 1:53 AM

I am so angry I think my head is going to spin. I come here so I know there are others like me.

constitutionlady on June 11, 2009 at 8:06 PM

Same here.

ConservadorRebelde on June 12, 2009 at 1:54 AM

Relax, Obama’s president now, you don’t have to pay for your mortgage or gas for your car….

Alden Pyle on June 12, 2009 at 7:30 AM

I’m slightly frightened that there is only a short stint where the change in monetary flow is below zero… Doesn’t that mean the Fed is constantly pumping more money in than it is taking out?

Does this give anyone else reason to get rid of the Fed?

When the economy is growing, then the money supply needs to grow also. As long as they maintain the same ratio then you have neither inflation nor deflation. The problem is that spike is an order of magnitude greater than normal growth, and we’re in a recession to boot.

The Fed is monetizing the debt, thinking that they can soak it back up when the economy improves, before inflation sets in. But much of the assets they been buying are of the toxic type, I expect they’ll have a harder time selling them than the bonds they usually buy. And as the 1970s proved, it’s entirely possible to have inflation without a growing economy.

LarryD on June 12, 2009 at 9:52 AM

There is a bright side (of sorts) to all of this crap coming at us at light speed – The Obozo voters are gonna be hit first and hit HARD!
.
We’ll have about three weeks to laugh at them.

Lanceman on June 11, 2009 at 10:15 PM

You know? This made me feel all better for about a minute. I’ll take it. Thanks! *checking wine rack for three week supply and liquor cabinet for back-up* We’re good.

BrideOfRove on June 12, 2009 at 10:56 AM

I’m an economics novice. Others keep mentioning money printed but not in circulation and therefore having no effect. If the money is not intented for circulation, then why print it?

MichiganMatt on June 12, 2009 at 3:52 PM

Skandia Recluse on June 11, 2009 at 12:08 PM

The Laffer curve was fully refuted by the Jimmy Carter presidency.

ernesto on June 12, 2009 at 4:06 PM

The Laffer curve was fully refuted by the Jimmy Carter presidency.

ernesto on June 12, 2009 at 4:06 PM

How was that done? Explain, or shut up.

Right_of_Attila on June 12, 2009 at 8:07 PM

Comment pages: 1 2 3