02 Jul 2011

Does Karl Denninger Understand How Central Banks Inflate Nowadays?

Federal Reserve, Financial Economics, Ron Paul 44 Comments

Although he occasionally notices stuff that other financial bloggers have missed, Karl Denninger apparently subscribes to the motto: “Speak loudly and carry a small stick.”

His latest tirade targets Ron Paul, who recently suggested (see the latter half of this video) that the Treasury just wipe away the $1.6 trillion in its debt held by the Fed.

Here’s what Denninger has to say about it:

Ron Paul has told us time and time again that he’s for “sound money.”  That is, money that doesn’t change in value.  Monetary policy that abides the actual statements in The Federal Reserve Act of 1913 (which, incidentally, The Fed has wantonly violated ever since with their so-called “inflation target”, whether explicit or otherwise.)

In fact, Ron Paul has consistently railed against that very inflation in essentially every case where he’s had Bernanke in front of him in a committee.

So let’s think through Mr. Paul’s “creative” solution.  Destroying the bonds The Fed holds while leaving the “excess reserves” that are on deposit, which The Fed creates with a push of a button to pay for those bonds, is in fact exactly identical to unbacked emission of currency.

That is, raw printing of money.

(Incidentally, that’s illegal under The Federal Reserve Act as well, but heh, who cares about the law, right?)

I have repeatedly and very publicly held that Mr. Paul has no clue what the hell he’s talking about when it comes to these matters.  That gold-backed currency does nothing to address the problems we face, and the empirical evidence backs my position (panics and wild bouts of both inflation and deflation under a metallic monetary standard.)  I further have charged repeatedly that Mr. Paul, despite multiple opportunities to grill Bernanke on the simple and easily-understood violation of the standard of stable prices in the Federal Reserve Act, has utterly failed to do so.

Now you know why: He doesn’t believe in stable prices and a stable and strong currency as he in fact is now suggesting intentional monetary inflation in an outrageous amount through this so-called “solution.”  This is exactly the sort of crap FDR ran in the 1930s – in fact, it’s functionally identical to FDR’s “executive order” gold devaluation!

To those who have supported Mr. Paul all these years, you’ve now seen his true colors.  Will you be man (or woman) enough to admit that he never actually understood what the hell he was screaming about, nor did he ever have an actual intent of restoring “sound money” to America?

We’ll see.

Well, since you ask, no Mr. Denninger, I will be neither man nor woman enough to admit such a thing. In our book, Carlos Lara and I had a similar proposal (namely for the shareholders of the Fed to just eat the capital write-down of the Treasury debt on the Fed’s balance sheet). Maybe we were horribly mistaken, but we sincerely thought it was a decent component of a strategy to restore sound money.

Denninger seems to think that a proponent of the gold standard and sound money–of all people!–ought to understand that we need some assets backing up our dollar bills, otherwise the Fed would have just been printing money. But what does Denninger think happened, say, in World War I, when the belligerents went off gold? Didn’t their central banks buy a lot of debt issued by their governments, to fund the war effort?

Or in the fall of 2008, is Denninger saying that it would have been inflationary and anathema to Ron Paul’s stated ideals, if Bernanke just literally handed over $1 trillion to investment bankers…but it would be OK if Bernanke instead handed over $1 trillion, in exchange for mortgage-backed securities that the market valued at the time at (say) $300 billion?

As with a lot of these things, the way to evaluate a non-optimal policy suggestion is to stack it up against a specified alternative. Yes, Ron Paul’s recent idea would be “inflationary” if the alternative would be a government running huge budget surpluses, so that the Fed could retire its holdings and shrink the monetary base over the next few years.

But that’s not at all what the likely alternative is. Rather, they are going to raise the debt ceiling, and Bernanke is going to print up another few hundred billion dollars out of thin air to absorb some of the new debt issued.

No worries though–those dollars will be backed up by IOUs that taxpayers will be forced to honor. Phew! I would hate for prices to go up on their own, without me being taxed too.

44 Responses to “Does Karl Denninger Understand How Central Banks Inflate Nowadays?”

  1. Anon says:

    What an ignorant buffoon. I know his type.

  2. Joe in Morgantown says:

    Thanks, Bob.

    I like Karl. He is opinionated and contrarian. Needless to say, he’s not always right.

    The fed is not going to be able to unwind their positions, anyway. We saw how they recoiled from the relatively modest recent Maiden Lane (non)sales.

    • Joseph Fetz says:

      “The fed is not going to be able to unwind their position, anyway”

      Yep, with a trillion in junk, and the bulk of the rest in treasuries, the only thing that will push them to unwind is runaway inflation and interest rates. But, by the time they even realize (admit) that is happening, they aren’t going to be able to find any buyers. It is a real catch-22.

  3. Mises von Ludwig says:

    Poor Denninger… he can see certain things aren’t right, but he just doesn’t get the whole picture. His tendencies are authortiarian, illustrated by how closely he moderates his forum and discourages any dissent. However, he does have good things to say about the mortgage mess and predatory lending.

    Attacking Ron Paul leaves me to believe that he is hopelessly stupid or an agent of the establishment. Either way I won’t read his blog anymore.

  4. Cygnusurania says:

    Karl is right. Bill Stiller is right. Dr. Paul is wrong, and I support Dr. Paul. Math doesn’t lie.


    CNN Article wrote..

    “We owe, like, $1.6 trillion because the Federal Reserve bought that debt, so we have to work hard to pay the interest to the Federal Reserve,” Paul said. “We don’t, I mean, they’re nobody; why do we have to pay them off?”

    Dr. Paul is wrong on this issue and so are you 🙂 Math doesn’t lie.

    • Dan says:

      Ok, can you explain the math. Not paying the fed has nothing to do with math but maybe you mean his idea would be inflationary. If so, go read Dr. Murphy’s post again. He responded to those concerns. You saying do the math doesn’t really add anything to the discussion unless you clarify what you mean by that.

  5. Cygnusurania says:

    Bill Still and Karl are right – as Iceland proved. http://www.youtube.com/watch?v=SixS1JMDgUk&feature=player_embedded

    We don’t have to pay the interest on anything. Dr. Paul is wrong on this issue. But I do support him over any other candidate.

    • bobmurphy says:

      Cygnusurania, how does this video prove Ron Paul is wrong? If anything, it is consistent with what Still is calling for–stop government borrowing from the central bank. Right?

  6. Brent says:

    TNR’s analysis of Paul’s proposal is far superior to Denninger’s. That’s not good for a financial blogger’s reputation.

    • bobmurphy says:

      Dillip Ranganathan had trouble posting this comment:

      “Incidentally (and I think the commenter Brent alludes to this), Dean Baker finds Ron Paul’s proposal fascinating. Link here.

      Greg Mankiw also has a post on it today.”

  7. Cygnusurania says:

    I don’t think Karl cares about reputation. The site is one of the busiest financial and freedom blogs out there. See the Tea Party Wiki for further description. Karl cares about truth.

  8. Joseph Fetz says:

    He lost me when he said that sound money is one “that does not change in value”. Everything after that was pure economic smegma; to put it lightly.

  9. David S. says:

    lol These are incredibly ignorant comments. My god, but the entertainment value on a slow Sunday morning!!!

    If the Fed’s national debt holdings are simply cancelled, you’ll have high and maybe hyperinflation, given both the real permanent increase in the money supply and the shift in expectations. The system we have now works fine at controlling inflation and has since about ’82, which is why implicit market inflation expectations are so low. I’m guessing this would undermine those expectations. lol

    You’re not an economist and even you admit you’ve been dead wrong about inflation at least during the last few years, and you feel qualified to comment on this? You’re a joke.

    • bobmurphy says:

      David S., I wouldn’t dream of saying you and I have comparable abilities as economists. (I mean that sincerely…) So spell it out for us, please, why this move would lead to hyperinflation-in terms of both the “real permanent increase” and the “shift in expectations.” Are you saying because the Fed wouldn’t be able to suck the reserves out of the system?

      • David S. says:

        The Fed could raise reserve requirements, etc., but it can only achieve so much if the Treasury starts canceling its debt and we keep borrowing, which we will. lol It would have to choose to buy different assets to avoid this when conducting OMOs, all of which would be seen as riskier and hence conventional monetary policy comes to an end at the very least, obviously. lol

      • Joseph Fetz says:

        I personally like Wenzel’s treatment of Ron Paul’s statement. Wenzel is a pretty sharp guy when it comes to debt instruments and currencies, and his explanation makes sense to me.

        • David S. says:

          Joseph, this is why Bob and his fans will always be peasants. They don’t understand the basics of economics or finance and never will.

          • Dan says:

            Oh snap, he got you there Joseph. How do you feel about yourself now. I mean that has to be the best put down ever. Have you ever seen such wit? Bow down to your overlord you simple peasant.

          • Joseph Fetz says:

            “They don’t understand the basics of economics or finance and never will.”

            Oh, I don’t know. I have a pretty high IQ, I am pretty sure that I can grasp just about any subject.

            • David S. says:

              Joseph, that statement alone tells me you don’t understand. It’s not all about IQ, but about some particular genotypical characteristics of the brain and the conditioned phenotype.

              • Joseph Fetz says:

                So, you’re now attempting to tell me that your inherited traits are more evolved than ours, that your conditioning and cognition is more developed and superior, and that because of this we cannot understand what you understand? Is that the gist of what you’re saying?

                oy gevaldt!

            • David S. says:

              Genotypic traits that happen to be more adaptive in the modern environment aren’t necessarily “more evolved”. Try learning something about evolutionary theory before addressing the topic.

              There’s a real simple test to determine if you’re one of the peasants I’m talking about. Are you financially independent and comfortably retired?

              • Joseph Fetz says:

                No, I work for a large company and make a good living. I do take 3-6 months off every year and I will be able to retire quite early in life. But, let me get something straight. Are you now saying that if somebody isn’t wealthy and retired, then that person is a peasant?

                Let me ask you, have you ever been diagnosed with a personality disorder (esp. superiority complex)?

            • David S. says:

              Son, in a capitalist economy, you’re either an owner or a slave. I’ve been kind enough to use the word “peasant”.

              • Dan says:

                I bow to your wisdom my lord. Shall I get a ruler so we can measure our manhood.

  10. David S. says:

    If the Fed chose to destroy the bonds itself, as opposed to the Treasury selectively defaulting, it would undermine the whole reason we choose to tax to spend in the first place: to control inflation. We could just have the government create new money to give fund its programs, but there’s a reason we don’t.. We don’t want to be Zimbabwe.

    • MamMoTh says:

      So wrong! The Treasury could selectively default on all bonds held by the Fed which would have the same effect as the Fed wiping out its holdings of government bonds. None of them will be inflationary in any sense. The only effect will be the same as rising the debt ceiling by 1.6 trillion dollars.

      • David S. says:

        Oh really? Is that what your GDP accounting identity tells you?

        Sorry, but I’m not interested in the MMT religion either.

        • MamMoTh says:

          No, just the fact that you contradicted yourself in one sentence is proof enough you don’t understand the monetary system either. You are in good company here.

          • bobmurphy says:

            Hitler vs. Stalin, I love it. No matter who loses, we win.

            • MamMoTh says:

              Sorry Benito, but when you say we, which of your cults are you referring to?

            • David S. says:

              You’re on the side of the inflationists in this case, not that it should matter to you. Yours just an ideology that cheer leads in economics.

          • David S. says:

            Look Mam,

            If the Fed chooses to eliminate the debt on its own initiative, at least a change in leadership there and/or drastic action like that taken by Volcker could return credibility. If the Treasury selectively defaults, conventional OMOs are finished and the Fed’s independence undermined.

            It’s about expectations, something you actually have to understand to understand monetary policy. Try reading a real economist like Friedman, rather than your MMT cult leaders.

            • MamMoTh says:

              Sure, it’s all about expectations and I didn’t expect you to understand how why your inflationist concern is nonsense.

              • Anonymous says:

                I think I’d do better talking to a Mormon about early American anthropology.

              • David S. says:

                I’d do better trying to talk early American anthropology with a Mormon.

  11. David S. says:

    By the way Bob, the liberal loon Dean Baker is with you on this:


    You’ve joined the inflationists!!! lmao

    Oh, and count in some MMT people!


  12. MamMoTh says:

    All this fuzz for something that is equivalent to rising the debt ceiling by 1.6 trillion dollars?

    It’s amazing how much silliness can generate being so ignorant about how the monetary system works. And that includes Ron Paul as much as Dean Baker.

  13. Bob Roddis says:

    it would undermine the whole reason we choose to tax to spend in the first place: to control inflation.

    “We” choose not to tax to spend in the first place for any reason, even to control inflation.

    Another good reason to abolish fiat money.

    David S. announces to the world that he has no familiarity with simple concepts like Cantillon Effects or the distortion of the price, investment or capital structure induced by fiat money dilution.

  14. Desolation Jones says:

    I got the impression Ron Paul didn’t really think the idea all the way through and probably wouldn’t have endorsed it had he understood the implications. Defaulting on on the bonds held by the fed with an inflation target is fundamentally different than defaulting on bonds held by regular bond holders, which I don’t think Ron Paul explored fully. He didn’t give much explanation or justification other than “Why do we have to pay them off?”.

    Bob Wenzel tried making fun of Denninger for apparently not understand monetary policy because the Fed could always raise reserve requirements. But Ron Paul didn’t even seem to have that in mind. Ron Paul said “But what they lose is their skill to manage the money supply and interest rates if they can’t buy or sell these treasury bills” as if the Fed would become powerless afterwards. So Ron Paul was either okay with hyperinflation or through some weird logic he though the only consequence of defaulting on the bonds would be the Fed not being able to inflate anymore than it already has. Or he thought hyperinflation was inevitable, but Ron Paul himself has complained about removing the liquidity before it’s too late so I don’t see him taking on that position.

    Anyway, if he did have raising reserve requirements in mind, Greg Mankiw is right that it would simply be an accounting trick. Raising reserve requirements is more or less a tax on loans. So it’s just shifting the tax to another location instead of paying it through a higher income tax or even lowering government spending. I find it odd that Ron Paul of all people would be endorsing a “dishonest” hidden tax just so the deficit looks better. Or maybe he thought this tax was some sort of payback on the banking system, but if so, why doesn’t Fed buy as much debt as possible, default on it, and raise reserve requirement as needed? Does Ron Paul not think this tradeoff would be harmful to the economy in some way that’s worth mentioning?

  15. Tel says:

    Allow me to put forward a modest proposal that might keep both Ron Paul and Karl Denninger happy. I’m making the first presumption that the US Federal Government can actually achieve a balanced budget, maybe even a small surplus. That really has to be the first step because it doesn’t make any kind of sense to try to get yourself out of the debt pit when you are still digging yourself deeper. We can argue elsewhere about how exactly a surplus could be achieved.

    OK, that leaves the massive federal debt, right? So what would happen if the US government started to buy gold? Well the speculators would go nuts and drive up the price of gold, so the government buys a bit, sends the price soaring, buys a bit more, etc. Up and up it goes (could be all PM, not just gold). Note that the government does not actually need to spend much money to achieve this, the speculators do all the heavy lifting.

    So let’s presume there is in fact some gold left in Fort Knox (arguable I know, but I’ll get to plan-B later on), so with the price of gold sky high, government offers to pay some of its employees in gold, not in FRN. In effect the government is selling gold but when the speculators see the shift that government is using gold (or any other PM) as a currency the price would not fall, it would keep going up. This price pump has two effects (or actually the same effect seen from two perspectives): firstly, although the nominal value of the US federal debt is still huge, it would effectively be devalued by the rising price of gold, secondly, the government now finds itself with a surplus of FRN that it can use to pay its debt (needless to say, the government never should pay the Federal Reserve back in gold, those particular debts would be paid strictly in FRN.

    As the gold goes out into the free economy and starts to circulate, people start to try to find ways to get rid of their FRN (which is by now devaluing fast) and overseas holders of treasury bonds and FRN get desperate to offload them before they devalue completely — the price of everything (denominated in FRN) goes up, which is inflation, but people wanting to avoid inflation can move to gold so the process accelerates. The US Federal Government’s hoard of gold is rapidly getting more valuable, and their ability to pay back their debt with badly devalued FRN.

    The end game is that the government no longer actually buys gold, but they allow people to pay tax in gold, which has the same effect. The FRN at this point would be essentially worthless paper — inflated into non existence.

    All upfront and legal like 🙂

    • MamMoTh says:

      The only way the government can achieve a balanced budget or a surplus is if the private sector starts increasing its level of indebtedness again and/or the external balance turns into surplus.

      You can try to guess which of the two options is less likely to happen in the foreseeable future.