More with Morris Davis

He’s probably my favorite economist, so I’m extending Morris Davis’ remarks to this column, with more thoughts shared during a recent radio interview with Jody & Joan.

IB: What grade would you give the U.S. treasury for it’s response to the recession?

MD: I think the treasury has looked terrible. If you were to aggregate a grade for the treasury, you would basically fail it. Why? It’s not clear the $800 billion stimulus (they haven’t spent all of that yet) has done anything. The Congressional Budget Office (CBO) … I know the economists there, and they are quite good; however, they cooked the books in their model such that the stimulus would have an impact. Most economists, and even the CBO estimates, suggest that the stimulus package — the money spent so far — has only lowered the unemployment rate by about 3/10 of 1%. Do we really want all of this debate and spending for only 3/10 of 1%? My view is no.

We’re hearing rumors of hyper-inflation next. Do you believe that’s a possibility?
I don’t think it’s going to happen. I’m on the Academic Advisory Council of the Federal Reserve Bank of Chicago; the Federal Reserve Bank presidents that I know quite well are extremely concerned about inflation, and they will fight it. But … they are not the only voice. And the U.S. does has incentives now to inflate. Here’s why:

First, China holds an enormous volume of our debt and our currency. The debt that it holds is not indexed to inflation. So we could essentially default on our obligations to the Chinese via inflation. We have that option; they have given that to us.

If I were the Chinese right now, I’d be buying real assets — golf courses or buildings or companies, just anything that is a real asset — as a hedge against inflation.

The second [reason to inflate] is that we are running big deficits. Historically, when governments run big deficits on a sustained basis, there’s always a bit of pressure for the Central Bank to jump on those deficits by printing money.

There are people who are extremely concerned about it who are going to do everything they can to not let it happen, and as it turns out there’s an enormous worldwide appetite for U.S. dollar denominated debt. So people are just holding this debt. As long as they are not spending it, it doesn’t have to lead to inflation.

Can you rate the FDIC’s performance?
The FDIC is tasked with shutting down banks, and the question is which banks to shut down. You could’ve made the case that we should have shut down all of the banks. I don’t have boots-on-the-ground connections with the FDIC. They were sure behind the ball two years ago, and there is still all this gossip about massive fights between FDIC Chairwoman Sheila Bair and Treasury Secretary Timothy Geithner. So it’s not to say that the federal government has a unified way of addressing fundamental solvencies. But my understanding is, the FDIC is making it harder for banks to loan than it used to be, and much more expensive.

Is this the right thing to be doing in the middle of a recession?
I don’t know. We know the consequence is that small banks are being shut down because they don’t have enough capital, and the ones sort of on-the-fence are being forced to call in loans to shore up their capital base. I think we have about 2,500 small banks; a whole group of these small banks are not really being allowed to make loans right now because of FDIC [directives].

If you’re going to shut down small banks, hold everyone to the same standard. This is what this whole idea of "too big to fail" is. Should Wells Fargo have been shut down? Probably. Should Bank of America have been shut down? Probably. Should Citibank be shut down? Yes. Why? These guys made, at the end of the day, a set of bad loans. They might debate that, but let’s have that debate.

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