Economic Soul Food
And
Understanding the Recession of 2008
by Mary A. Ayala, Ph.D.
Published by Mary Ayala
Smashwords Edition
Copyright 2010 Mary A. Ayala
ISBN 9781456327491
This ebook is licensed for your personal enjoyment only. This ebook may not be re-sold or given away to other people. If you would like to share this book with another person, please purchase an additional copy for each recipient. If you’re reading this book and did not purchase it, or it was not purchased for your use only, then please return to Smashwords.com and purchase your own copy. Thank you for respecting the hard work of this author
Chapter 1 New Federal Housing Policies That Should Revitalize the Middle Class (9-22-2010)
Chapter 2 Redistributing Wealth the Power of Wall Street and the Federal Reserve (9-7-2010)
Chapter 3 Are U.S. Investors Fleeing Away from the Stock Market? (8-23-2010).
Chapter 4 Lowering the Cost of Home Mortgages without Refinancing (8-16-2010)
Chapter 5 Rediscovering the Importance the Middle Class to the Recovery of the Economy (7-30-010)
Chapter 7 Finding Financial Security During Recessions (6-27-010)
Chapter 8 The Current Recession-How Long Will It Really Last? (4-10-2010)
Chapter 9 Managing the National Debt (4-05-2010)
Chapter 10 Show Me the Money in the Housing Market (12-29-2006) (Postscript-10-2-2010)
Chapter 11 Beyond the Recession of 2008 (10-17-010)
*****
Acknowledgements
To Nancy, Betty, Kiko
& My Children
This book answers questions that many Americans are asking today about their future. For example, one American recently spoke plainly to President Obama at a public meeting. Covered on TV on September 22, 2010, this individual said that she had once been an avid supporter of Mr. Obama during his campaign for the presidency. Then, she added that two years later she was tired of defending the President’s agenda… tired of many other things as well, I suspect. Finally, she asked the President “Is the American Dream over? Is this my new reality?”
These questions deserve a response. But, a response is not one that any recent President has been able to provide because our nation’s current economic and social problems have evolved over the last thirty years. This brings us to the situation today, a Congress divided by two political parties that cannot get beyond their differences.
I believe Americans can pursue an “American Dream” as our parents did before us. However, the problems that created the state of our economy today have to be understood first before we, as a nation of pragmatic problem solvers, can move forward in one or more complimentary directions. When that time arrives, it will be unacceptable for political parties to argue about providing either entitlement programs or tax incentives unless they have wide public support for them among the taxpayers who will be required to pay for them.
I am confident that the many advisors to Congress and to the President are aware of the nation’s problems; but, they may differ with respect to their proposals for solving these problems. As a practical matter, however, most Americans are not fully aware or fully informed about either the problems or the strategies for solving them because both are complicated. Therefore, this book attempts to cut to the core of these complicated issues so that the problems and solutions can be discussed in classroom settings or in town hall meetings. The material avoids eco-speak as much as possible. In short, this book is important, because if most Americans are not equipped to be vigilant watchdogs of their personal rights and their financial security, these rights and their wealth will quickly be taken from them. I titled this book, “Economic Soul Food”, not to suggest that the title is an oxymoron, but to suggest that economic issues can be exciting and useful food for thought.
The future holds many possibilities for this nation; undoubtedly there will be many ways to make these possibilities a reality. Therefore, the outlook for the economy should be addressed because one man’s dream might be another’s nightmare. Now and beyond the current recession, Americans need agendas they are willing to support and fund.
This book deals with various economic policy issues that the President, his advisors, and Congress have addressed since November of 2008 in order to pull the U.S. economy out of the recession. Each chapter was published previously on my website and each is time-dated in the Table of Contents because my particular views were not always supported by Congress when I published them. Some have been supported recently and others have been ignored. Chapters 1 through 10 provide the background for understanding the problems that this nation faces. Chapter 11 discusses strategies for solving these problems.
Chapter 1 New Federal Housing Policies That Should Revitalize the Middle Class (9-22-2010).
This morning I took time to research the feasibility of lowering my monthly mortgage payments by looking at the eligibility requirements of the federal loan programs that have been created to assist financially distressed homeowners. I was interested primarily in a loan modification program that would lower monthly payments permanently by lowering an interest rate or the principal balance on a mortgage. I went to my lender's website and checked out my options by completing an online questionnaire that the lender uses to pre-qualify applicants for one or more of the federal programs. I indicated that I was current in my payments, but my income had dropped. This might have been caused by either a temporary involuntary layoff or involuntary early retirement.
I tried several responses to the lender’s question about the value of my liquid financial assets. Initially, I responded to one question by indicating that my liquid assets totaled $8,000, but I was disqualified from the program. A re-entry of $5,000 produced a response that I might be eligible for a loan modification. Therefore, assuming this lender's questionnaire accurately reflects the eligibility requirements for this program, I will have to wait until I am delinquent in my payments and/or have less than $5,000 in liquid assets before I might qualify for an interest rate reduction. The description of this relatively new federal loan modification program did not include any reference to lowering the principal balance on my mortgage. However, there are forbearance plans that reduce principal payments temporarily.1
The major omitted qualifying criteria for the current federal loan modification program is that nothing is asked about a homeowner's financial losses that might justify lowering the principal balance permanently. For example, with respect to a different federal program, if the market value of a mortgaged home falls below a mortgage's principal balance, there may be some assistance if the owner has to sell his home at a loss. That is, a lender may agree to what is referred to as a ‘short sale’ which means it is willing to write off the loss or the federal government is willing to reinstate the lender for the difference between the sale price and the seller's higher mortgage balance.
As far as I can tell, the Federal Home Modification Program does nothing for the financially stressed homeowner who cannot afford to sell his home because he needs to recover the equity that would be lost at point of sale in order to be able to purchase a different home. Illustrating, suppose that a household purchased its primary residence in 2005 for $390,000. Assume it can be sold today for $310,000; and the principal balance on the mortgage is $310,000. Is this a problem? Well, yes! It can be a serious problem because this hypothetical household is locked into staying in its home unless it can afford to take an $80,000 loss. Not many middle class homeowners can do this. Therefore, this loss constitutes a major penalty imposed on some homeowners that has not been addressed in any of the new federal programs for distressed homeowners; and there are millions of homeowners who are faced with this problem. Understandably, when private citizens and banks invest in real estate and/or any forms of intangible assets, they do so knowing that there are risks attached to them. However, between 2000 and 2007, the U.S. financial industry engaged in a massive Ponzi scheme, or scam, that produced an unstable housing market and overvalued, mortgaged homes. 2 Ordinarily, when financial schemes harm a large group of investors who were misinformed about the quality of securities they purchased, the SEC investigates and the U.S. Justice Department takes the individuals responsible to court in order to confiscate any funds that are available. Therefore, I doubt anyone would argue that nothing should be done to offset the losses that many investors and homeowners have been forced to absorb. Perhaps, the sheer magnitude of the damage inflicted on homeowners has been so great that Congress does not want to propose a remedy. But, this could be a monumental oversight during an election year.
Footnotes
(1) According to the Federal Housing Finance Agency’s Finance Committee’s Foreclosure Prevention and Refinance Report for the first quarter of 2010, cumulatively since the home modification program began, 138,000 home modification plans have been completed which lowered interest rates. Eighteen thousand forbearance plans and 56,000 repayment plans have been completed. The forbearance plans reduce monthly payments until a homeowner can catch up. Source: http://www.fhfa.gov/webfiles/15860/1Q10FPR.pdf
(2) Literally, a Ponzi scheme is a pyramid investment swindle in which supposed profits are paid to early investors from money actually invested by later participants (Source: Encarta World English Dictionary). A scam refers to the act of obtaining money from somebody by dishonest means. Therefore, ‘scam’ is probably a better label for the activities that created the financial crisis.
Chapter 2 Redistributing Wealth - The Power of Wall Street and the Federal Reserve (9-7-2010)
Today millions of unemployed people in the U.S. are searching for work; but businesses are standing on the sidelines waiting for signs of an economic recovery from the current recession before they will hire workers. Prices of durable goods are falling because businesses are trying to unload their inventories to consumers who cannot afford them unless credit terms are extremely attractive. But, the credit market has been very tight for over a year. On the other hand, the costs of other goods and services have risen, suggesting that inflation or stagflation (i.e., high unemployment coupled with inflation as experienced during the recession of 1980) is a more likely prospect.
As of this writing, opinions have varied so widely about whether the U.S. economy is going to experience inflation or deflation that only speculators who take financial positions in interest rates, foreign currencies, and foreign exchange rates can benefit from this environment. However, several noteworthy economists have already documented the disruptive effects that financial speculators had on various countries’ attempts to recover from their recessions. Mainly, they stated that speculative attacks on interest rates and currencies created excessive volatility in these markets which undermined confidence about the governments of various countries. In some cases, the public’s lack of confidence and/or distrust led to panic, runs on banks, and capital flight (Krugman, P., 2009). 1 Therefore, speculation about these rates adds volatility to financial markets that is not healthy for the U.S. economy.
Formal announcements of the government’s position regarding its strategies for lowering unemployment rates and controlling prices are about the only thing left at the moment that will curb financial speculation in currencies and interest rates; and these announcements have not been forthcoming. Moreover, formal announcements of targeted economic objectives and strategies for achieving price stability are only useful if they are backed up by visible/transparent actions. For example, Paul Volcker, who preceded Alan Greenspan as the Federal Reserve Board's (FRB's) chairman and who is currently a member of the President Obama’s Economic Advisory Council, jacked up interest rates during the U.S. recession of 1980 because he needed to dampen speculation about the possibility of hyperinflation.
At this point in time, the President is preparing to release a new set of policies that will influence the programs his Administration will use to reboot the economy. In other words, the President and Congress underestimated the impact that the financial meltdown of 2008 would have on consumers and producers. They assumed that implementation of Keynesian “Depression-style” fiscal and monetary policies that worked in the 30’s would jump-start the U.S. economy; but this did not occur because the practices of the financial industry have altered the behavior of producers and consumers.2 Moreover, the federal policies that have been implemented to date have not restored wealth to individuals and producers. They have been redistributing wealth in the form of entitlements, which may or may not restore the economy to pre-recession employment and income levels. Keynes’ Depression model did not deal with inflation or the redistribution of wealth (Keynes, 1936). The remainder of this chapter does address them, however.
The Outlook for Inflation and Deflation
What do we actually know about the current U.S. economy today, and how does it differ from the economy as it existed during the Great Depression of 1929? My answers to these questions are presented below in highly simplistic terms. For a polished understanding of the situation, I refer again to (Krugman, P.,2009). I begin by describing the U.S. economy as if it were the only country in the world. I end by describing the U.S. as a member of a global economy. The former is commonly referred to as a “closed” economy; and the latter is referred to as an “open” economy. In each case, I consider the redistribution of wealth that occurs when the money supply is altered by one or more sources; and I address the causes and impacts of inflation in both a closed and open economy.
Inflation in A Closed Economy
How much money is needed in circulation? Well, that depends on how much output a nation produces and how its consumers place a value on each product or service relative to another. How does inflation occur? There are several possibilities. First, a shock to the U.S. economy such as a spike in domestic oil prices might drive up the cost of many other items that use oil or some derivative of it during production or the distribution phase of production. Second, it might be caused by a shortage of domestic labor that would drive up wages. This is unlikely during a recession with high unemployment rates (i.e., with an excess supply of available labor). Third, the government might stimulate the economy by printing money with the intent to drive down interest rates, promote investment, and create jobs. This strategy has not been working during the current U.S. recession, mainly because businesses and consumers are uncertain about Congress’ ability to regulate the financial industry and our monetary authority’s ability control/stabilize prices.
Keynes’ rationale for using deficit spending did not address inflation because following the stock market crash in 1929, Keynes’ Depression model focused on restoring an economy after deflation (i.e., a massive reduction in the general price level) already occurred. Inventories were overstocked and over 20 percent of the labor force was unemployed. Therefore, from this starting point, Keynes argued that governments could engage in deficit spending in order to put unused labor and idle machinery back to work temporarily without putting upward pressure on prices. He argued that a recovery from an economic recession depended on the federal government’s ability to stimulate and reestablish consumption expenditures. Why should inflation be such a concern at the moment? It is a concern because Keynes' macroeconomic model ignored inflation. Therefore, he did not address the fact that major directional changes in some or all prices can redistribute wealth from one group to another. Keynes confined his concerns to the restoration of aggregate levels of employment, income and consumption expenditures. Therefore, examples provided below will illustrate how inflation redistributes wealth.
Inflation That Redistributes Wealth
I begin by illustrating how inflation can redistribute a nation’s wealth in a “closed” economy. The following assumptions simplify the explanation. Assume the U.S. economy only produces two goods: butter and bread. If a pound of butter is worth twice as much to consumers as a loaf of bread, then the monetary value of 1 pound of butter must be double that of a loaf of bread. Assume the national output is 1 million loaves of bread and 1 million pounds of butter. All of these items are exchanged every day. Assume, one shopkeeper handles the transactions because buyers and sellers cannot meet each other at exactly the same time and place in order to exchange goods. In order to handle these transactions, the shopkeeper decides to perform the function of a bank by creating fiat money called “green beans” (GBs). 3 Based on total output, exactly 3 million GBs are needed to cover daily transactions. Having added no products to the economy, as long as the shopkeeper does not create fiat money for himself, everyone is satisfied with the monetary system.
Continuing with this example, suppose our industrious shopkeeper/banker decides to double all prices and print 6 million GBs instead of the 3 million GBs. Before he announces that prices will change, he purchases all of the butter and bread from producers at their original prices. When the producers return to the shopkeeper as consumers a day later, they learn that all prices have doubled which means they can only purchase half the amount they purchased previously for the 3 million GBs they have to spend. At the end of the day, the shopkeeper owns half a million pounds of each product and 3 million GBs. Some might argue that this would force the shopkeeper to reduce his prices in order to eliminate his inventory. But, this is too rational. It does not explain why the shopkeeper raised prices and doubled the money supply in the first place.
In the real world, a government’s central bank attempts to ensure that prices and the money supply remain stable. Therefore, it would have no reason to double the money supply in order to put upward pressure on prices.4 However, if a third party such as the shopkeeper/banker, described in the example of a closed economy, can double the money supply…or influence it… without being caught, it will be able to redistribute wealth in the manner that I have described. Of course, producers will notice and raise their costs eventually. Therefore, it is the interim before consumers and producers raise their prices when wealth is redistributed. I will demonstrate how this occurs in the following sections. But first, how does this example compare with the current situation in the U.S? Analogies are never perfect; but when unregulated U.S. financial intermediaries overpriced collateralized debt obligations (CDOs) between 2001 and 2008 and sold them to investors, they were creating an inflationary environment for certain markets in the economy (e.g., They were selling a CDO for $2 million instead of its real market value which was $1 million). These overpriced CDOs were high interest bearing bonds secured by home mortgages; and their market values collapsed as soon as large numbers of homeowners defaulted on their mortgage payments.
These CDOs were lucrative for several years during which time investors who search for higher returns shifted their funds from other holdings to the home mortgage market. The injection of additional capital into the housing mortgage market created an easy credit environment for home buyers. Easy credit increased the demand for homes. Home builders could not build enough homes to keep up with the demand which put upward pressure on home values. As a result, home values skyrocketed until the foreclosures caused the housing market to crash.
Given the hypothetical inflationary scenario for the bread & butter economy, and another actual scenario for the U.S.’ housing market prior to 2008, one might ask why the bread and butter economy did not crumble (pardon the pun)? The simplest answer to this question is that producers and workers doubled their prices almost immediately in the bread and butter economy which counteracted the inflated prices set by the shopkeeper. This adjustment did not occur in the U.S. economy. Between 2000 and 2005, the median value of mortgaged housing grew much faster than household income.
Returning to the bread and butter economy, what does the shopkeeper in the bread and butter economy do with his unsold inventory and the extra 3 million GBs? The simplest answer to this question is that the shopkeeper will extend credit to consumers when they cannot purchase bread and butter at their original prices. This clears the shopkeeper/bank’s inventory of bread and butter; but consumers are now in debt to the shopkeeper for $3 million GBs. In the real U.S. economy, lenders extended credit to both prime and sub-prime rate homebuyers. The increase in the demand for homes gave way to a construction boom that could not satisfy the demand. Home values jumped; but as soon as the sub-prime borrowers defaulted on their mortgage payments, an enormous number of vacant homes depressed prices. Some of the sub-prime borrowers many of whom obtained loans with no down payments, lost their homes, but they invested nothing in them. However, many of the other buyers who purchased homes during the housing bubble still have mortgages to repay. They are indebted to lenders for principal balances on their overvalued mortgages, which would have been substantially lower if there had been no housing bubble or if home values had kept pace with growth in household income.
Concluding this section about the redistribution of wealth that can occur in an inflationary environment, this example can be expanded to cover the redistributive effects of inflation when the prices of all goods do not increase at the same rate. Some of these changes are beyond a nation’s control. But, to the extent that prices can be controlled, this chapter explained why Congress grants the Federal Reserve Board (FRB) exclusive authority to control them by either expanding of contracting the money supply in order to maintain stable economic and financial conditions that benefit consumers. The FRB has to be impartial in order to maintain the general public’s confidence in the stability of U.S. currency.
Inflation in A Global Economy
Extending the previous example, in a two-nation world (the U.S. and Islandia), assume that U.S. bread and butter producers realize that they are more efficient producers of butter and Islandia’s producers realize they are more efficient producers of bread. Therefore, each country decides to specialize. To expedite the transactions, each country creates its own money supply. Assume that consumers in both countries are willing to pay twice as much for butter as they are willing to pay for a loaf of bread. Therefore, the monetary value of one pound of butter will be double that of a loaf of bread in either currency. Assume also that each country issues the same amount of currency. The U.S. issues (GBs); and Islandia issues Carrots (Cs). If this situation could be maintained indefinitely, the two countries could actually agree on a common currency because the currency exchange rate is 1:1 (i.e., a consumer can purchase one pound of butter for either 2 GB or 2 C; and a consumer can purchase one loaf of bread for either 1 GB or 1C).
Now, let us assume that the U.S. doubles its money supply when production levels have not changed. Expansion of the money supply eventually doubles the price of butter, just as the shopkeeper/bank did in the previous example. The price of domestically produced bread that would have cost 1GB, if the U.S. had not stopped producing it, would now cost 2GBs to purchase domestically. The currency exchange rate should adjust; but these adjustments are neither immediate nor perfect. Therefore, initially U.S. consumers continue to import bread by exchanging 1GB for 1C which is the cost of a loaf of Islandia’s bread. However, Islandians will have to exchange 4Cs for 4 GBs in order to purchase 1 pound of butter from a U.S. producer. Therefore, the U.S. exported some of its inflation to Islandia….which may not be exactly what Islandia’s government desires unless it is interested in expanding its exports and reducing its imports.
Hypothetically, Islandia’s reaction to this situation explains why many people speculate or invest in currencies when they are uncertain about the impact an increase in the U.S. money supply will have on prices. Clarifying this point, suppose Islandia does not want to pay twice as much for butter as it did before prices in the U.S. doubled. Therefore, Islandia’s central bank might decide to intervene in the currency market to stabilize the GB by deflating U.S. prices. Intervention by Islandia’s central bank might entail buying (i.e., absorbing) the additional GBs that the U.S. created. However, if Islandia’s central bank purchases the GBs, the U.S. currency will be held as reserves in Islandia’s central bank which will expand the supply of Cs. As a consequence, Islandia’s intervention will strengthen the U.S. GB (i.e., deflate U.S. prices); but it will inflate prices in Islandia unless this country’s real output level can expand to accommodate the growth in Cs.
Concluding this section on the prospects of U.S. inflation or deflation, in a global economy, foreign intervention would have to be massive in order to offset the unfunded expenditures that are planned in the U.S. in the future; and the downside is that U.S. trading partners will eventually have to deal with inflation in their countries unless they can justify expanding their money supplies by growth in their real output levels. Therefore, the prospect of deflation in the U.S. is unlikely. The prospect of deflation that the FRB creates is even less likely as long as U.S. output, measured in real dollars, is expanding.
Conclusions
This article highlighted the inflationary impacts that an increase the money supply can have on prices and the redistribution of wealth. Macroeconomists are generally concerned with the impact that an increase in the money supply will have on all prices, ignoring the distributional impacts on wealth. However in the examples provided in this chapter, inflation redistributed wealth from consumers to a shopkeeper/banker in a closed economy; and it redistributed wealth from Islandia to the U.S. in a global economy.
By illustrating the impact that inflation can have on the redistribution of wealth, this chapter also explained why Congress has granted the U.S. Federal Reserve Board (FRB) exclusive control over changing the money supply which influences U.S. prices and credit markets. The Recession of 2008, however, proved that unregulated or loosely regulated segments of the U.S. financial industry were large and powerful enough to have a temporary inflationary impact on housing values through its control of credit markets which redistributed wealth from households to mortgage lenders.
Finally, this chapter demonstrated by example, why federal programs that attempted to jump start the U.S. economy in 2009 were unsuccessful, albeit they were modeled in part on Keynes’ doctrine that deficit spending could help a nation recover from an economic recession or depression. First, Congress broke away from Keynes’ model by enacting large unfunded entitlements which may not have been the best strategy for recovering from the recession because these entitlements were primarily a means of redistributing wealth, as opposed to being the catalyst for creating jobs and new wealth. The bailout of certain poorly managed financial companies in 2008 was an entitlement that redistributed wealth from homeowners to banks. No new jobs were created. Second, Congress continued to enact unfunded entitlement programs in 2009 and 2010. These programs including healthcare, HAMP and HOPE will also redistribute wealth. Third, Congress delayed until June of 2010 before it began to address the credit-requirements of small businesses that will be able to create real products, services and jobs. Some critics claimed that Congress was obsessed with health care reform, while millions of Americans waited on the sidelines in desperate need of jobs.
In closing, this article takes no position on the value of U.S. entitlement programs. All entitlement programs would not have been enacted into law unless they served some worthwhile purpose; but that is not the issue at hand. The subject of this article is that the deficit spending that Keynes recommended was wealth to poorly managed financial companies not justified because it would redistribute or to citizens who did not or could not add to the productive capacity of the economy. Keynes argued that creating jobs by relying on federal deficit spending would recover an ailing economy without inflation or long-term debt. In other words, by putting resources back to work and improving infrastructure (e.g., roads, the TVA, etc.), these changes would increase productivity and output above pre-depression levels, so that there would be no inflationary impact associated with deficit spending. Redistribution of wealth and rising national debt levels were never part of the picture.
Footnotes
(1) Paul Krugman is the recipient of the 2008 Nobel Prize. He has authored several books, one of which highlights the difficulties various countries had when they could not recover easily from their economic recessions because of fluctuations in the value of their currencies. Speculation in the foreign exchange market and capital flight worked against government policies designed to stabilize a national economy. Argentina’s experience between 1990 and 2002 is one of many examples that Krugman describes (Krugman, pp. 98-99).
(2) John Maynard Keynes (1883-1946) is the noted British economist who spearheaded an entirely new movement regarding the causes and cures of business cycles or economic depressions. After WWII started, Keynes’ theories became popular; but the federal policies and programs that were designed to end the Great Depression of 1929 were based on Keynes’ theories.
(3) Fiat money is paper money that a government or its authorized agent may issue. But, its value depends on a government’s decree that is not convertible to other stores of wealth such as coins or gold.
(4) The basic idea is that the central bank creates and adds to the money supply when higher output levels warrant it. It does not do so ordinarily in excess of growth in real domestic product because of the possible redistributive wealth effects. However, there are exceptions. For example, some monetarists believe that an expansion of the money supply will create a. temporary expansion of jobs and output.
Chapter 3 Are U.S. Investors Fleeing Away from the Stock Market? (8-23-2010)
Most reporters do exactly what their names imply. They report on the opinions of experts; but some give little thought to the reasonableness of the responses they are given by the individuals who they chose to interview. For example, on the status of the stock market, they search out pundits in the financial industry. However, some of these individuals led investors down a path to insolvency for the last 10 years. Therefore, these individuals or their replacements are not necessarily going to be any more insightful or truthful today than they were a decade ago.
I believe these pundits will continue to be creative; and they will try to maximize corporate profits and/or bonuses. But, the advice given to reporters for the general public should be taken with a grain of salt. An article published recently in the New York Times is a case in point.1 The article states that many investors have pulled millions of dollars out of their mutual funds in order to make what they deem are safer investments…like bonds.
There is nothing unusual about minimizing risk; but, the obvious choice of bonds as the “safer” form of investment is not necessarily a safer choice today. Years ago when a triple-A rated corporate bond was actually worthy of a triple-A rated designation, this may have been true. However, the financial wizards who created dubious financial securities and the bond raters who assigned triple-A ratings to them have undermined the credibility of their “paper”.
What about U.S. purchasing U.S. Treasury bonds? Are they a safer investment? The last time I looked which was yesterday (August 20th 2010), the 30-year U.S. Treasury bond rate was 3.66 percent. Therefore, unless you are purchasing a Treasury bond that is indexed to inflation (known as a TIP), a 30 year U.S. Treasury bond is not absolutely risk-free.2
What other reasons might explain the flight of investors from the U.S. stock market? One possible answer is capital flight. For many years, the U.S. monetary and financial system was reputedly cited as a “model” to adopt in developing countries when their currencies were unstable because politically motivated agents determined the quantity of currency that would be created in their countries. Illustrating, in the U.S., Congress has granted the Federal Reserve Board (FRB) the exclusive responsibility for controlling the money supply in order to control inflation and ensure full-employment. Today we realize that it may be difficult to hit two moving targets with one bullet, the bullet being the interest rate. Nevertheless, historically, the FRB has functioned independently of the whims of Congress in order to serve in the best interests of the nation's economy. This role has not changed. However, the financial crisis of 2008-09 demonstrated that the U.S. financial industry can be a major source of inflation, price instability, and frozen credit markets. In developing (i.e., emerging) countries that experienced price instability and hyper-inflation (i.e., double digit inflation) during the 80’s, the residents of these countries exercised two options in an effort to maintain their wealth and purchasing power. They could take their currency out of the country and convert it to a stable foreign currency, which between WWII and 2005 was the U.S. dollar; or they could purchase tangible items that kept pace with their countries’ inflation rates. The governments of these developing nations discouraged capital flight in the 80’s which left many locals with the second option. They purchased land, farm equipment, cattle, chickens, etc..