Morningstar Advisor - April/May 2012 - (Page 51)

to increase the deficit. From a policy point of view, what is your diagnostic of why we have such low growth? What would be the appropriate policies to steer the U.S. economy toward higher growth? Sargent: I’m going to appeal to some empirical evidence. There’s massive evidence that most business cycles aren’t associated with a financial crisis, a banking crisis, or an exchange crisis. With recessions that are not associated with a banking crisis, recoveries tend to be quite fast. That’s fact number one. Fact number two is, if there’s been a banking crisis, the evidence is the real economy recovers very slowly. So we are right on track with that. Torralba: Essentially what Carmen Reinhart and Ken Rogoff say in This Time Is Different. Sargent: Yes, they say it, but other people said it before them. It’s in Understanding Financial Crises, a wonderful book by Douglas Gale and Franklin Allen. It’s all there in the data, and we’re right on track. When the banking system gets messed up, all sorts of financial constraints that weren’t operating in normal times start operating. Banks and financial intermediaries can’t do what they’re supposed to do. Thomas Sargent If the whole price level jumps up and the value of real assets go up, lots of balance sheets that are in bad shape would be repaired. Lots of people who thought they owned assets would lose them, but in a way, this massive redistribution would repair the state of a lot of financial institutions. It would solve the mortgage crisis. It’s been done before. Hong Kong did it in 1983. Torralba: What would a quick episode of inflation be like? Sargent: We’re doing theory, OK? It isolates a It’s a hypothetical experiment, but it identifies a pressure for inflation. I’m speaking theoretically, but the quote-unquote “advantage” of this is that the courts will say a dollar is a dollar. There are no disputes. Torralba: But governments have to be careful with how they handle inflation. It’s in your paper “The Ends of Four Big Inflations.” What does the government need to be careful about when it allows inflation to rise? Sargent: That is the question. The answer is The banks have to get in better shape. They won’t say this, because the Fed’s under a lot of political pressure, but a big part of the low interest-rate policy of the Fed is designed to repair banks’ balance sheets—but at the cost of harming people like my father, who are dependent on interest rates on safe assets. By the way, there are other ways to do it. There is a smooth way to do it that’s been done before—and you don’t say this in public—but it’s to have a very rapid inflation. If you do some calculations, what a fast inflation does that’s unanticipated is that it transfers resources from creditors to debtors. It writes down debts smoothly. pressure that’s there for inflation. Everybody knows this. Olivier Blanchard [chief economist of the International Monetary Fund] said a little bit of this, and he got hammered. But an example would be, just do it, a 30% jump in the price level. People say that would be difficult to do. No, it wouldn’t. You could figure out how to do it very fast. All prices go up by 30%. Just check what that does to your balance sheet. Your house, even if the real value is down, your house goes up by 30%. Your mortgage, which is nominal, stays where it was. You’re suddenly over water. All those mortgage-backed securities that were underwater, they’re fine. what dominates policymakers’ response to this crisis. There’s some history of this. Go back 100 years. At that time, the world’s on a gold standard, which is about to be threatened because World War I is about to start. But almost every academic in a monetary authority said that gold standard’s the only way to go. “You just can’t print money. It’s off the table.“ In the meantime, there were these scholars— Irving Fisher and John Maynard Keynes—who said, “Well, actually, theoretically you could do better than the gold standard.” They said you could have a well-managed fiat standard and you just use the quantity theory of money and limit the quantity of money. That MorningstarAdvisor.com 51 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2012

Morningstar Advisor - April/May 2012
Contents
Contributors
Letter From the Editor
We’re Too Smart
How Do You Use Alternatives?
Taking the Lead
How to Find Economic Moats
The Beauty of Currencies
No Clarity on Bonds
Four Picks for the Present
Investment Briefs
Performance Chasing, Evaluated
Technology’s Slim Pickings
How Much Is Enough?
The Fear Bubble
Three Traits of a Successful Long-Short Equity Manager
Why Absolute-Return Funds Fail to Deliver
An Economist’s Response to Crises
Undiscovered in Plain Sight
Untangling ETF Tax- Efficiency Myths
Central Banks Driving the Gold Rush
U.S. Industrials Could Add Some Magic to Europe-Weary Portfolios
No-Hesitation Allocation Funds
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Greatest Story Ever Told

Morningstar Advisor - April/May 2012