Monday, November 15, 2010

The Totally Confused Nouriel Roubini

Nouriel Roubini is a very wired in guy, when he comments about what this, or that, central bank is going to do, I pay attention. Chances are he is advising that central bank and they have informed him of exactly what they are going to do.

He also is a great data collector. He has an impressive staff and likes to study the numbers, when he spews out numbers I also pay attention, but when it comes to economic theory, there is no chance I pay attention to Roubini.

He comes out of the Keynesian school of economics and just doesn't understand money or the business cycle. Case in point. During a recent interview with Ash Benningtonm at CNBC's NetNet with John Carney, Roubini said:

Increasing base money is not inflationary because M0 more than doubled in the last year and a half—since QE1—but velocity has collapsed
First off, I am not sure why Roubini is talking about  "M0 money--M0 is cash money, coins, bills etc.

The Fed via QE2 is doing many things and some of QE2 may translate into M0, but QE2 will for the most part end up as part of M1 and M2, e.g. in demand deposits.

Secondly (and here Roubini has no clue becasue of his Keynesian leanings) M0 climbed last year and a half becasue there was an extraordinary demand for cash. People were in a panic and unsure of what would happen next in the economy, thus their desire to hold cash exploded. As this demand subsides (and it is doing so now), the amount of money held as cash will be less so on a relative basis compared to M1 and M2 (though on an absolute basis it may climb given the huge money printing of QE2).

Roubini then brings up "velocity", which I happened to have discussed last week:

During periods of  high inflation expectations, people will have a much lower demand for cash relative to other goods. That is, if they think prices will go up and they will buy today rather than wait until tomorrow, thus keeping their cash balances low--and pushing prices up. This is what econometricians and other mathematical economists call velocity, which is really a distortion of the non-mathematical more precise term, desire to hold cash balances. (Expect Evans and other WSJ reporters to start babbling about climbing velocity in about six months.)
Thus, it is kind of bizarre for Roubini to say there is no inflation threat because velocity is low. If you take away the mumbo jumbo of the pseudo mathematical preciseness of the  term "velocity", and think in terms of demand to hold cash. The first question to ask is, "If the demand to hold cash was high last year, who says this is a constant that will stay high next year?" or to frame this in elevator shoe economics, "If velocity was low last year, who says it has to be low next year?"

But by Roubini couching things in pseudo mathematics, he doesn't understand the economic forces acting on "velocity", so he makes the bizarre assumption that velocity won't change. If, however, you think of it in terms of human action, i.e., the desire to hold cash balances, it becomes obvious why there was a strong desire to hold cash balances in the panic period and why that demand is thawing now and will certainly turn into a desire to limit cash balances as price inflation already in the system (see commodity prices) becomes more obvious at the consumer level.

What I said last week when I was discussing this very topic relative to a column by Kelly Evans, applies just as much to Roubini:

In addition to her failure to understand the influence of the desire to hold cash balances and its impact on prices, Evans amazingly doesn't recognize the influence of QE2. With Bernanke blasting for weeks that QE2 was coming, a couple of people might actually think that inflation will be climbing...Bottom line, Evans is going to be very surprised about the huge uptick in inflation that is coming. The desire to hold cash is declining and Bernanke's QE2 is going to bomb the planet with hundreds of billions in new high powered money.

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