Antipodes Speak Out – Lacker and Evans
Over the past two weeks we have heard several regional Fed presidents speak their mind, some of whom oppose the central bank's current easy money policies and some of whom think it should ease even more. Members of the Fed's board of governors in Washington and chairman Bernanke were also heard from – this group seems to be united in wanting to pursue an extremely easy monetary policy. We will look at some of the speeches that were delivered, with special emphasis on Charles Evans, as his viewpoint seems to be gaining ground lately.
First we got to hear from 'hawk' Jeffrey Lacker again, the president of the Richmond Fed, who spoke to a group of businessmen in Salisbury, essentially repeating what he had said a week earlier already.
Lacker once again stressed that he doesn't believe that 'Operation Twist' will do anything to revive economic growth, but that it may well lead to rising prices. However, he also mentioned a new and interesting aspect raising what in our opinion is quite an important point:
“Richmond Federal Reserve Bank President Jeffrey Lacker said Monday that he does not support the central bank's Operation Twist move to help to recovery. "My sense is that the main effect will be to raise inflation somewhat rather than increase growth." [always keep in mind that when a Fed member mentions 'inflation' he or she is referring to the rate of change in the consumer price index, ed.]
“Lacker also said he did not support the Fed's decision to reinvest proceeds from maturing agency mortgage-backed securities into the agency MBS market. Previously, the Fed had reinvested the proceeds into Treasurys [sic,ed.]. "It is simply inappropriate, in my view, for a central bank to channel credit toward some economic sectors and away from others," Lacker said.”
Lacker is absolutely correct on the point highlighted above. By directing credit to a specific sector of the economy, the Fed without a doubt deprives other sectors of the economy. In this particular case the mistake is compounded by the fact that the Fed is directing more credit to a sector of the economy that is in urgent need of further liquidation and redirection of malinvested capital and needs to be allowed reach a market clearing level if its health is to be restored. All additional resources that are artificially directed toward this sector will only serve to delay the necessary readjustments and waste more scarce capital in the process. Note here to Lacker's point that the pool of real savings in the economy is limited, so when the Fed showers new money created from thin air on a specific sector, the sector's ability to bid for resources increases relative to that of other branches. The extent to which this redirection of scarce resources occurs is precisely the extent to which alternative employments of the same resources can not be undertaken by others. Wealth generation will be hampered.
We should add to this that even if the Fed did not explicitly direct credit toward a specific sector of the economy but instead – as it normally does – were to merely accommodate credit expansion by the commercial banks passively, i.e., by supplying reserves so as to sustain an interest rate target below the natural level, very similar effects would be observed. Credit expansion by commercial banks does not happen in a vacuum after all. Which sectors of the economy will be the first recipients of newly created credit and money depends on the specific market data of each historical case, but when interest rates are kept below the natural rate, the bulk of investments will generally take place in higher order (capital) goods production or other long-duration investments (the housing sector is similar to capital goods from an analytical point of view, due to the long duration of services rendered by real estate).
Credit creation in each specific case will anyway always end up favoring certain industries over others.
However, it is still better to leave the decision to the private sector than leaving it entirely to the central bank. Currently the private sector has pulled back from pumping more credit into the real estate sector (this is not only due to the fundamental economic reason that the sector needs to liquidate malinvested capital and the housing market has yet to 'clear'. It is inter alia also due to the string of government interventions in the mortgage credit market over the past three years, which have made life extremely difficult for private sector mortgage lenders. This point has been discussed in more detail in Ramsey Su's articles). The Fed intends to create a fresh impetus for more credit creation in the mortgage sector, but as we noted above, this is a serious mistake. What should be implemented instead is a credible plan to wind down the operations of the GSE's (this is not the province of the Fed of course, but it certainly helps to perpetuate these interventionist entities by buying up their debt).
The Evans Gambit
Another regional Fed president who was heard from again was Charles Evans of the Chicago Fed – currently one of the most 'dovish' Fed members, whose idea we have named the 'Evans gambit' in allusion to a famous chess opening (named after the Welsh sea captain William Davies Evans who introduced the gambit in 1827. It goes: 1. e4 – e5; 2. Nf3 – Nc6; 3. Bc4 – Bc5; and now: 4. b4 – the 'gambit pawn' that the leader of the white pieces offers as a sacrifice in order to achieve a positional advantage).
Evans delivered a speech entitled 'The Fed’s Dual Mandate Responsibilities: Maintaining Credibility during a Time of Immense Economic Challenges' to the Michigan Council on Economic Education.
First Evans launches into a description of the 'enormity of the economic problem' we face, naming 'Paul Krugman, Mike Woodford and other economists' like them as the ones he 'largely agrees with', and citing the Keynesian shibboleth of the 'liquidity trap' as the primary economic problem. There is a lot of nonsense that just won't die, and this particular one serves as a very convenient excuse for supporting inflationism and deficit spending as the best 'cures' for economic recession. So far it's not working, but such facts curiously never intrude very much on the convictions of Evans and the economists he names.
Even those who are convinced that Evans is correct in his diagnosis will have to admit that he omits an important point: he doesn't explain how it was possible for us to even arrive in this dreadful situation. Given his conviction, further stressed in the remainder of his speech, that the Fed's central economic planning is beneficial, such an 'immense economic challenge' should never have arisen. After all, the Fed's polices were a crucial factor influencing economic development before the bust as well.
Further along in the speech Evans addresses some of the concerns that have inter alia been frequently mentioned by his more hawkish colleagues (he refers to them as the 'Fed's critics', without letting on that several of these critics are actually members of the Fed):
“Recently, many critics of the Fed’s actions have raised concerns about the credibility of Fed policy. Credibility — that is, the general belief that the Fed does what it can to achieve its mandated policy objectives — is certainly a critical issue. Defining “credibility” sounds easy, but there are several aspects to credibility. For example, at any point in time, the Federal Reserve will likely need to contemplate a series of current and future policy actions in order to effectively influence the trajectory of the economy and better achieve the goals of monetary policy. In order for households, businesses and financial markets to conduct business in accordance with the Fed’s planning, the public must believe that the Fed will carry out these future actions as expected to achieve its well-understood objectives. Credibility requires a clear public understanding of the Fed’s policy objectives, as well as a belief by the public that the Fed’s actions are consistent with achieving these objectives. Lower levels of credibility would be associated with erratic and misunderstood policy actions that seemed inconsistent with the stated objectives of monetary policy.”
What is immediately clear from the above is that Evans is convinced that it is appropriate for the market economy to be lorded over by what is in effect a socialistic central economic planning agency that – in his words – needs to 'influence the trajectory of the economy'. It is probably not a big surprise that a Fed official would make this assertion, but it most definitely should be questioned. How can it even be considered possible that a handful of bureaucrats will know better which 'trajectory' the economy should take than the market economy itself? Why should it be held that such a state of affairs is even remotely desirable?
This sudden obsession with 'credibility' must be brought into context. Numerous protest movements have sprung up in the US, from the 'Tea Party' to the 'Occupy Wall Street' demonstrations, and although many of the protesters likely don't know precisely how the modern monetary system works, they do know that something has gone wrong. Institutions such as the Fed that took credit, or were credited by others, for the boom can not escape becoming a focus of criticism during the bust. In addition, as Bob Prechter has pointed out in his most recent issue of the 'Elliott Wave Theorist' (more on this further below), 'the Fed not only suffers from an internal split, it has never had fewer friends in Washington than it has now'. A recent editorial by Ron Paul (recommended reading) excoriating the Fed that appeared in the Wall Street Journal has provoked an unusually large number of reader comments – the vast bulk of which seem to be in agreement with Paul's analysis.
So yes, the Fed has a credibility problem, but it is no longer merely confined to the 'price stability' and 'inflation expectations' question (which seems to be the major concern of the 'hawks').
Evans then launches into a description of the 'monetary policy deliberation process' the Fed engages in before setting sail on a specific course. He unwittingly admits that socialist central planning is in fact an impossibility – in the sense that it can not deliver what its proponents insist it can: smooth economic development.
Consider what he says below – we intersperse a few brief comments [bold and in brackets].
“First, members of the Federal Open Market Committee (FOMC) must have a clear vision of the goals of monetary policy. In my mind, the Federal Reserve Act is very clear in specifying that the Federal Reserve has a dual mandate: The FOMC should provide for monetary and financial conditions that support maximum employment and price stability. [How can that possibly be achieved by tweaking an interest rate and/or pumping up the money supply?]
With regard to inflation, we should seek to keep inflation near 2 percent over the medium term.
We should also remember that a 2 percent objective should represent an average level of inflation, not an impenetrable ceiling
[he refers to the rate of change of a price index – as we have pointed out before, this 'stability policy' is erroneous and dangerous. Evans prepares the ground for explaining why 'higher inflation' should be tolerated at present. This is the course the BoE currently pursues].
With regard to our real economy mandate, we should minimize the deviations of the actual path of the real economy from its potential path (or more technically, its efficiently-achievable path)
[they can not even know what that 'efficiently-achievable path' is].
From my earlier discussion of the immensity of the current problem, we are far from minimizing these real deviations today [duh].
Second, the FOMC needs to closely look at the plethora of data that comes out every month in order to evaluate the outlook for the economy and inflation, keeping in mind a variety of potential risk scenarios and financial stability considerations.[this is the main – and insurmountable – problem central planners face in a nutshell. It is not possible to even collect, never mind correctly interpret the 'plethora of data' and bring them into context with a 'variety of scenarios' in such a manner that the 'correct policy' for a correctly foreseen scenario ends up being picked] .
Four times each year, the FOMC formally publishes forecasts in its Summary of Economic Projections. Of course, it is crucial for each FOMC member to update his/her outlook for each meeting [even if they updated their outlook every single day, it would not alter the basic problem]
Third, in evaluating the state of the economy and inflation pressures, the FOMC must periodically step back and ask itself whether something very different than normal is afoot. We all recognize that our views about how the economy works are imperfect. [and yet they have the competence to plan the economy?]
So we must always ask if we have seen anything that would move us away from our current viewpoints and forecasting methodologies — and if things have changed significantly, we must ask if achievable paths for our policy goals or the channels through which monetary policy works have been altered in any substantive way. [regarding their forecasting record, it has proved rather poor, so this is a legitimate question. Unfortunately it is nigh impossible to improve on that, and even if they did manage to do that, it would still not justify their interventions]
These considerations would include questions about whether we are facing structural economic change that lowers the economy’s potential output, substantial financial impediments holding back demand along the lines stressed by Reinhart and Rogoff, global financial stress, and the like. A good portion of these concerns are related to appropriate risk-management considerations. [the 'impediments' discussed by Reinhart and Rogoff presumably concern mostly the degree of government indebtedness. Their book looks at empirical case studies and concludes that once government debt exceeds a certain threshold it becomes a drag on economic growth. The implication for Evans is probably that in such cases, monetary pumping must replace deficit spending. As to the economy's structural problems, they are the result of the preceding boom that easy monetary policy caused].
Fourth, policymakers must make a decision regarding the stance and course of monetary policy. They must ask if their forecasts are consistent with their medium- and long-term policy objectives, and if not, what then is the best response for monetary policy to influence the trajectory of the economy and inflation in order to meet the FOMC’s objectives? [this is a question to which no answer exists. If one did, then central economic planning would in fact make sense and bring about the desired results. It does however the opposite].
That is a very quick summary of the necessary steps for effective monetary policymaking.”
Evans then returns to the credibility question, noting that there have been times when the Fed's credibility suffered and times when it was comparatively high. He cites specifically the 1930's and 1970's as examples. We would put it as follows: whenever the stock market goes up, their policies seem to 'work'. When it goes down, they don't seem to work.
“Since no policymaking process can be perfect, some errors will naturally arise. At the forecasting stage, no one has a perfect crystal ball. Forecast errors will be made, and these errors could have an impact on credibility. It seems natural to believe that greater losses would occur if there were repeated mistakes in economic projections of a one-sided nature.”
You don't say. Here we should perhaps point out that there exists a process that is clearly superior to 'policymaking' with its many flaws: the unhampered free market economy. We should try it sometime.
“At the policymaking level, a continuing pattern of not taking appropriate policy actions in the face of a changing economic outlook or structure would presumably lead to poor outcomes against medium-term goals. Now, caution in policymaking can be a virtue. But at some point, when the weight of the evidence is large, continued delays in action could erode credibility. [this is in Evans' view the current problem: the Fed is allegedly 'too cautious']
In general, although a policymaker’s credibility account is credited and debited on a regular basis, the most substantial credibility losses come in two varieties: 1) really large and systematic deviations of outcomes from ex ante chosen policy objectives; and 2) a substantial misunderstanding of policy objectives. Monetary economists often point to the poor economic experiences of the 1970s and 1930s as times when the Federal Reserve’s credibility account was debited substantially because of both of these factors.”
What he is in fact telling us is that as long as a boom continues, people are prepared to believe the most preposterous stories, including the one that the seeming health of the economy can be credited to 'economic policy' implemented by central economic planning institutions such as the Fed. In reality the boom eventually always leads to a condition deemed rather unsatisfactory, namely a bust. The bust is the economy's attempt to heal itself; to purge the distortions of the boom and rearrange its structure of production to correspond to the realities of consumer demand. The bust reveals the mistakes of the boom – and as such it naturally implicates policy makers that indeed must take responsibility for having fanned and rationalized the boom. Every time this happens, the preposterous stories people were eager to believe during the boom naturally meet with more and more incredulity. That's actually a good thing.
Evans continues and begins to fantasize a bit:
“I believe the current liquidity trap environment following the 2008 financial crisis is similarly challenging today’s policymakers. [translation: we've been busted]
So far, I believe we have done the right thing. [that assessment requires a huge leap of faith to put it mildly].
Since the recession’s end in 2009, more than once the FOMC’s projections have proved too optimistic, and the U.S. economy has been unable to achieve escape velocity for returning to stronger, self-sustaining growth. [how come?]
But instead of doing nothing, the FOMC took further policy actions to support stronger growth in the context of continued price stability. [one would think it's high time to question these policies then, in light of the outcome, but no....]
These actions have provided a credible counterweight to the forecast errors and maintained steadfastness with our medium-term policy objectives. [now he's fantasizing].
I’m not so sure how well we will do going forward. [since they can't unmake the mistakes of the past, refraining from compounding them would be a good start].
Alas, as one would expect, for Evans the failure of the Fed's policies in the course of the bust to date are not a reason to rethink or abandon them; he thinks they should be intensified.
“My recent speech in London on dual mandate arithmetic was meant to clarify the challenges we face in describing the Federal Reserve’s policy objectives. [there's no need to clarify anything; anyone in possession of more than two brain cells probably realizes that it's not possible to comply with the 'dual mandate' except by luck].
The upshot I take from that analysis is this: If we sit on our hands as the economy withers relative to our mandate, then we could take a huge hit to our credibility, akin to what happened to our credibility following the devastating mistakes of the 1930s.”
And while it is correct that the Fed made a string of mistakes in the 1930's, this is the wrong thing to focus on. The biggest mistakes occurred during the boom of the 1920's. In the 1930's a lot of effort was expended on redoubling the same mistakes, which is why what might have been a sharp and short recession turned into a long lasting depression. It would be entirely wrong to say that the Fed was 'sitting on its hands' during the bust that began in 1929. On the contrary, its policy recipes were not substantially different from today's.
The Fed's credibility didn't suffer because it made no effort to pump in the 1930's – it suffered because the structural damage the economy had suffered during the boom was so great that it became glaringly obvious that the policy didn't work and in fact made matters worse.
In his description of the historical data surrounding the episodes of the 1970's and 1930's contraction, Evans implies that Federal Reserve officials of both eras misinterpreted the economic data, and hence reacted 'wrongly' by pumping too much in the 1970's and not enough in the 1930's. Allow us to point out here that the Fed in both periods did what it always does when a bust strikes: it pumped. It doesn't have any other 'policy lever' than creating more money from thin air by various methods.
Naturally Evans then dismisses the critics of today's unprecedented monetary pumping efforts by noting that he thinks we're in a replay of the period when the Fed allegedly didn't pump enough (in short, all roads lead to more money printing):
“Critics point to the large expansion of bank reserves and low levels of interest rates throughout the Treasury yield curve and surmise that the Fed is sowing the seeds of future inflation, as in the 1970s. They believe we should be taking back accommodation — some say now, some say soon — as the recovery gains some more steam or inflation creeps up a few more tenths.
I don’t see it that way. Rather than fighting the inflation ghosts of the 1970s, I am more worried about repeating the mistakes of the 1930s. As in the 1930s, today we see a lack of demand for loans and a resistance of lenders to take on risk — factors that mean the high level of bank reserves is not finding its way into broader money measures. As in the 1930s, today’s low Treasury interest rates in good part reflect elevated demand for low-risk assets — we see investors run to U.S. Treasury markets every time they hear any bad economic news from anywhere in the world. Consider another metric for interest rates, the well-known Taylor Rule, which captures how monetary policy typically adjusts to output gaps and deviations in inflation from target. Its prescriptions would call for the federal funds rates to be something like –3.6 percent now, well below the zero lower bound the funds rate is currently stuck at. Our large-scale asset purchases have provided additional stimulus, but by most estimates not enough to bring us down to the Taylor Rule prescriptions.”
The blind faith that a mathematical construct can actually be used to determine how much monetary pumping there should be is entirely misguided. How does Evans know that – given the lack of a crystal ball which he admitted to earlier in his speech – he actually interprets the economic situation correctly? Even if he did so, it would not follow from this that more monetary pumping can 'fix' the economy.
Since money printing can not create any wealth, it can only lead to a shifting around of existing wealth – the redistributive effect Lacker mentioned. It as a hindrance to the necessary economic adjustments the bust attempts to achieve. To be sure, the short run effects of a strong dose of monetary pumping usually make it appear as though the policy had a positive effect: asset and commodities prices rise, alleviating the pressure on bank balance sheets and creating speculative profits. Economic activities spring up that would not be pursued absent the artificial demand monetary pumping introduces. At the same time though all of this make the lives of most producers and wealth generators more difficult, as they have to contend with rising input costs. Consumers never get to see the falling consumer prices that would make their incomes stretch further – real incomes in fact tend to decline. Within the Fed, only Thomas Hoenig, the now retired former president of the Kansas Fed, clearly identified artificially low interest rates and money printing as causing the central problem of resource misallocation and malinvestment.
Evans then goes on to describe the current dilemma as one consisting of a trade-off between 'inflation' (i.e., the effects of the inflationary policy on the 'general price level') and unemployment. He diagnoses that the reason that the economy isn't improving is that the public expects the Fed to soon tighten monetary policy again (in other words, he doesn't realize that the worsening of economic conditions is a long run effect of monetary pumping).
“I believe that we can substantially ease the public’s concern that monetary policy will become restrictive in the near to medium term and, hence, reduce the restraint in expanding economic activity [we have yet to hear from anyone in the business community who's actually concerned by this].
This can be done by clearly spelling out in our policy statements the conditionality of our dual mandate responsibilities. What should such a statement look like? I think we should consider committing to keep short-term rates at zero until either the unemployment rate goes below 7 percent or the outlook for inflation over the medium term goes above 3 percent.[why not 6% and 4% Or any other number pulled out of one's hat?]
Such policies should enable us to make progress toward our mandated goals. But if this progress is too slow, then we should move forward with increased purchases of longer-term securities. We might even consider a regime in which we reevaluate our progress toward our policy goals and the rate of purchase of such assets at every FOMC meeting.
In short: the money supply must be increased further. Evans doesn't stop to ask how it is possible that a time period which has seen more money supply growth than occurred in all of preceding history (since the end of 2000, the US true money supply has increased by 165%) was concurrently the period that produced the worst economic performance since the end of WW2 and the worst stock market performance ever. It remains a mystery why neither he nor most of his colleagues at the Fed stop to question this fact.
True money supply components since 2000 (legal categorization), via Michael Pollaro; at end 2000 the total stood at $3.017 trillion. At end of September 2011 it had grown to $8.003 trillion, an increase of 165%
Year-on-year growth of the main components of TMS-2 since 2000; as an aside, the most recent growth spurt was egged on by dollar deposits fleeing Europe.
TMS-2 components by economic categorization. The periods when money supply growth accelerated the most coincided with economic downturns, while a slowdown in money supply growth preceded said downturns. Note that the big increase in covered money substitutes is due to the Fed's QE programs, which inter alia create massive amounts of free bank reserves.
Considering the above charts, it seems clear that whenever money supply growth slowed down (in the year 2000 and the years 2005-2007), the effects of the previous inflationary period dissipated and the economy fell into recession, as uneconomic activities depending on easy money were unmasked and began to be liquidated.
This does not mean that recession can be averted forever by the expedient of growing the money supply. Eventually, a crack-up boom and catastrophic collapse of the currency system would occur. Given the evidence it is curious why Evans and others at the Fed believe that more of the same will be a good thing.
Internal Critics and Supporters
Among the current crops of dissenters in the Fed, Richard Fisher recently remarked:
“I happen to believe that the Federal Reserve is exhausting the limits of prudent monetary policy. The programs popularly known as QE2 and Operation Twist are, to my way of thinking, of doubtful efficacy, which is why I have not been able to support them. I suspect that, at least in the case of Operation Twist, they have so far been of greater benefit to traders and large monied interests than to job-creating businesses. But even if you believe, as the majority of my learned colleagues do, that the benefits of QE2 and Operation Twist outweigh their costs, you would be hard-pressed to now say that still more liquidity, or more fuel, is called for given the $1.5 trillion in excess bank reserves and the substantial liquid holdings businesses are hoarding above their normal working-capital needs.
Even surveys of small businesses—for example, the U.S. Chamber of Commerce’s survey of companies with less than $25 million in sales and fewer than 500 employees conducted in July, or the National Federation of Independent Business survey of September – indicate that fewer than 10 percent of small enterprises (which employ half of the private sector’s workers) are having problems accessing credit.
I would submit that adding more liquidity, or making money still cheaper, is not the answer to our problems.”
This is obviously quite different from Evans' idea that businesses will expand if only they can be assured that no monetary policy tightening is imminent. Fisher is of course quite correct as to who profited the most from the recent Fed efforts. Regarding economic forecasts, Fisher had this to say:
“Kenneth Arrow, a Nobel Laureate in economics, had his own perspective on forecasting. During World War II, he served as a weather officer in the U.S. Army Air Corps and worked with a team charged with the particularly difficult task of producing month-ahead weather forecasts. As Arrow and his team reviewed these predictions, they confirmed statistically what you and I might just as easily have guessed: The corps’ weather forecasts were no more useful than random rolls of a die. Understandably, the forecasters asked to be relieved of this seemingly futile duty. Arrow’s recollection of his superiors’ response was priceless: “The commanding general is well aware that the forecasts are no good. However, he needs them for planning purposes.”
Keep Professor Arrow in mind when you hear economists tout precise forecasts carried out several places to the right of the decimal point. You may need economists’ forecasts for planning purposes, but you should always take them with a grain of salt, even when the time horizon is a short one. I direct you to an article in the Feb. 14 edition of the Wall Street Journal as evidence. The Journal had polled 51 leading economists, and they forecast that gross domestic product would expand 3.6 percent in that very same first quarter, ending in less than a month’s time. Growth came in at 1.9 percent.”
Nonetheless, Fisher is not doubting the value of the Fed's activities as such, in spite of practically admitting that they are flying blind. This contradiction is impossible to explain.
Charles Plosser likewise expressed his doubts, saying that while he doesn't fear a large increase in 'inflation' (rising prices) in the near term, he believes that the excess reserves held by banks represent the fuel for same in the future. In an interview with the German paper 'Handelsblatt' he noted:
“When the business cycle improves and the reserves flow in the economy, then that is fuel for inflation. As long as we can control that, and as long as the public believes that we can control that, it will not cause inflation, also in the future."
Plosser expressed frustration that the central bank's monetary easing had not helped the economy more, and said that might be due to them not having the right instruments available [of course not; money printing can not create wealth, so how is it going to help the economy?]
"We must not only understand what monetary policy can do, but as well what it cannot do," Plosser said. He also said that monetary policy cannot substitute for fiscal policy and urged the government to reduce uncertainty by getting a grip on budget discipline.”
'Fiscal discipline' is something the Fed various members are also not really of one mind about. Similar to low 'inflation', many think it should only be a 'medium or long term goal'. Let's have fiscal discipline, but not just yet.
Late last week more voices in support of additional easing measures were heard – which no doubt helped with goosing the stock market a bit. First Daniel Tarullo (a member of the board of governors in Washington), who normally doesn't engage much in public opining on monetary policy, pleaded for additional easing via monetization of more mortgage backed securities.
One of the objectives of this plan – so Tarullo – is to induce investors to buy more risky securities – in other words, the objective is to blow another bubble. Tarullo considers a 'shortfall in aggregate demand' the economy's most pressing problem. However, demand is never really an 'economic problem'. It can not be, until the day arrives when all wants are satisfied. This and similar underconsumption theories were unmasked as fallacies long ago, but remain highly popular. The scarcity of resources and their optimal allocation to best satisfy the wants of consumers represents the central economic problem – and this is not something that can be improved by the intercession of planners.
Lastly Janet Yellen, vice-chair of the Fed, announced her support for both Evans' idea of announcing specific thresholds for the eventual tightening of policy and the idea of embarking on yet another large scale asset purchase program – as :
“Federal Reserve Vice Chairman Janet Yellen said a third round of large-scale securities purchases might become warranted if necessary to boost a U.S. economy challenged by unemployment and financial turmoil.
The central bank should also give “careful consideration” to Chicago Fed President Charles Evans’s proposal to tie the near-zero interest-rate pledge to specific levels of unemployment and inflation, Yellen said today in a speech in Denver.
The remarks signal Fed officials may be prepared to delve further into unprecedented monetary territory and take criticism inside and outside the central bank for expanding the balance sheet. Fed policy makers are struggling to lower unemployment that’s been stuck near 9 percent or higher for 30 months without boosting inflation that’s already close to the central bank’s long-run goal.
“Securities purchases across a wide spectrum of maturities might become appropriate if evolving economic conditions called for significantly greater monetary accommodation,” Yellen said in prepared comments to the annual meeting of the Financial Management Association International.
The U.S. recovery is “disappointingly slow,” which leaves the economy “vulnerable to downside shocks,” Yellen said. Job growth is likely to remain “tepid in the coming months,” and the chance that Europe’s sovereign-debt crisis may pressure U.S. financial companies is “particularly worrisome,” Yellen said.”
Yellen's entire speech can be found here.
Shortly before these two speeches were delivered, Ben Bernanke let loose on the technicalities and evolving philosophy of central banking, also proving that he remains the consummate planner. He inter alia announced that central banks will henceforth be 'better' at manipulating the economy because the financial crisis has taught them so many valuable new things. Seriously.
The precise wording of that astonishing conclusion reads as though a sketch writer for a stand-up comedian had a hand in formulating it:
“An evolving consensus holds that central banks can dedicate separate toolkits to achieving their financial stability and macroeconomic objectives, but this consensus must be viewed as provisional. Certainly, those toolkits appear to be much better stocked today than before the crisis: monetary policy tools that can be brought to bear if necessary include the management of the central bank's balance sheet and, to a greater extent than in the past, communication about future policies. Financial stability policy encompasses, as the first line of defense at least, a range of microprudential and macroprudential tools, both structural and varying over the cycle, supported by enhanced monitoring and analysis of potential risks to systemic stability. Clearly, understanding and applying the lessons of the crisis will take some time yet; both theorists and practitioners of central banking have their work cut out for them.”
This is an enormous mouthful of utterly meaningless gibberish (as is the rest of the speech). If someone were to slightly reprogram the it would probably spit out similar stuff. Here is what the 'better stocked toolkit' has achieved thus far:
The so-called 'misery index' – a simple addition of the U3 unemployment rate and CPI – reaches a new multi-year high – click for higher resolution.
In connection with this unbroken willingness to foist more monetary experimentation on us, a recent remark by Bob Hoye is well worth quoting:
“To be serious, policymakers are becoming more dangerous in their endless experiment to prevent bad things from happening. The danger is that intervention has become a one-way street without any of the policy chips being taken off the table.
In engineering terms this is a positive feedback mechanism that will accelerate itself to mechanical destruction. The latest version of fractional reserve banking has no deliberate braking mechanism that will curb speculative excesses.
Saving the financial world may still be the ostensible goal, but underneath this veneer of respectability these guys are out to prove that their theories really work. What's more, they won't willingly quit until their tinkering blows everything up.”
This latter point is no doubt true, as can be ascertained by considering all of the above. However, one should probably keep an open mind about whether it will come to the point where their tinkering will be allowed to blow everything up. As Bob Prechter notes, the change in social mood has made things far more difficult for the Fed. The political headwinds are getting stronger the more its extraordinary policies are seen to fail and the more unpleasant side effects they produce (think $4/gallon gas).
On the other hand, it may not be too much of an exaggeration to state that four decades of unbridled credit expansion in a full-fledged fiat money system have brought us to a 'point of no return'. Consider again the money supply growth charts we showed above. The fractionally reserved banking system has flagrantly overtraded its capital and expanded its assets willy-nilly, while the economy's structure of production has concurrently gone through numerous distortion and discoordination phases and was never allowed to fully correct them. In short, even while the unproductive debtberg grew out of all proportion, the real economy's ability to generate wealth has been ever more impaired.
As a result all it takes for a crisis to break out these days is a mere slowdown in money supply and credit growth. So there will constantly be new ostensible reasons to resume inflationary policy even if political headwinds should produce the occasional pause (the ECB currently faces such a situation – money supply growth in the euro area has slowed to a crawl over the past year and a crisis has broken out in the wake of this).
The Western central bank that is the furthest along in abandoning even the last semblance of discipline is the Bank of England at this point in time. It has decided to completely ignore its price stability mandate in the face of the economic downturn, providing a string of excuses as to why it should no longer be guided by data that once were at the forefront of its decision making process. Note here that we are not saying that it should pursue a certain type of policy – as far as we are concerned the market economy would be best off without central banks. We are merely pointing out that the BoE is an example for how easy it is to abandon monetary discipline altogether in the face of a perceived economic emergency.
Charles Evans proposes to abandon monetary easing if 'inflation' should increase above 3% – presumably in that case, even a 15% unemployment rate would not sway him from embarking on monetary tightening. However, if that is true, one wonders why he proposes further easing at this time, given that the year-on-year rate of change of CPI currently stands at 3.8%.
The year-on-year rate of change of CPI is already way above Charles Evans' proposed 'upper bound'. What gives? – click for higher resolution.
Central bankers are in an unenviable situation; we have some sympathy for their increasing desperation. Cherished theories that were always held to be valid are not easily abandoned; cognitive bias will tend to overrule all objections, whether they are of a theoretical nature or consist of a growing body of empirical evidence. Moreover, they are indeed faced with a unique situation in a sense, as we have arrived at what is probably the endgame for the full-fledged fiat money system that has been in place since 1971. Never before have such daunting mountains of unproductive debt been amassed and rarely has the fractionally reserved banking cartel been in more profound trouble.
To this we would note that the proposal to monetize more MBS will primarily help the banks, which continue to face enormous risks due to the decline in collateral values backing their real estate loans and the ongoing legacy challenges from the bubble period (such as California issuing a subpoena to BAC over 'toxic securities', or JPM and BAC admitting that they are receiving ever more refund demands from investors, concerning both pre- and post-bubble loans). Recently the Fed nodded and winked when BAC decided to transfer its derivatives risk to a subsidiary enjoying FDIC insurance (not surprisingly, the FDIC is somewhat less enamored of the prospect).
While the Fed has been primarily founded to serve the banking cartel, we are not saying that its current members are not honestly interested in improving the economic situation. Charles Evans and others in his corner probably mean well. Nevertheless, their interventions are only making things worse and will continue to do so.
When monetary pumping is stopped or paused for a while, the liquidation of malinvestments is bound to resume. The short run effect will very likely be an even more profound bust. Such short term outcomes will then serve as rationalizations for renewed pumping. Paul Krugman, whose economic philosophy Charles Evans identifies himself with, would undoubtedly let loose with a barrage of 'told-you-so's' while these short run effects play out. Curiously, we never hear from him when an alleged economic catastrophe on account of fiscal austerity and monetary rectitude turns into a success story after a little while (such as e.g. Estonia's and Iceland's strong recoveries; we have also noticed that ever since Ireland has fallen off the 'crisis map', Krugman doesn't mention it anymore). The truth of the matter is in fact demonstrated by these success stories. By allowing a bust to play out unhindered, one may suffer comparatively more short term pain, but the prize to be attained in the form of long term gain is well worth it. By contrast, the attempt to continually avoid suffering short term pain by means of deficit spending and monetary pumping condemns the economy to a never-ending malaise.
It should be obvious that problems created by easy money and too much debt can not be solved by even more easy money and even more debt accumulation – alas, as illustrated above, this common sense realization has yet to dawn on our vaunted policymakers.
Charts by: Saint Louis Federal Reserve Resarch, Michael Pollaro
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