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The Fed’s Dangerous Game: A Fourth Round of Stimulus in a Single Growth Cycle
The Fed’s Dangerous Game: A Fourth Round of Stimulus in a Single Growth Cycle
The longer the signals in capital markets go haywire under the influence of “monetary stimulus,” the bigger is the cumulative economic cost. That is one big reason why this fourth Fed stimulus — in the present already-longest (but lowest-growth) of super-long business cycles — is so dangerous.
True, there is nothing new about the Fed imparting stimulus well into a business cycle expansion with the intention of combating a threat of recession. Think of 1927, 1962, 1967, 1985, 1988, 1995, and 1998.
This time, though, we’ve seen it four times (2010/11, 2012/13, 2016/17, 2019) in a single cycle. That is a record. Normally, a jump in recorded goods and services inflation, or concerns about rampant speculation, have trumped the inclination to stimulate after one — or at most two — episodes of stimulus.
Also we should recognize that the length of time during which capital-market signaling remains haywire, is only one of several variables determining the overall economic cost of monetary “stimulus.” But it is a very important one.
Haywire signaling is not just a matter of interest rates being artificially low. Alongside this there is extensive mis-pricing of risk capital. Some of this is related to the flourishing of speculative hypotheses freed from the normal constraints (operative under sound money) of rational cynicism. Enterprises at the center of such stories enjoy super-favorable conditions for raising capital.
There are also the giant carry trades into high-yielding debt, long-maturity bonds, high-interest currencies, and illiquid assets, driven by some combination of hunger for yield and super-confidence in trend extrapolation. In consequence, premiums for credit risk, currency risk, illiquidity, and term risk, are artificially low. Meanwhile a boom in financial engineering — the camouflaging of leverage to produce high momentum gains — adds to the overall distortion of market signals.
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Why Powell Fears a Gold Standard
Why Powell Fears a Gold Standard
Chairman Powell’s testimony last week was closely scrutinized not just for its economic implications but also for its political overtones. Powell cited “trade tensions” as cause for concern about the strength of the global economy. He clearly seemed to be blaming President Trump’s tariffs.
But if the tariffs are what ultimately move the Fed to cut rates, Trump will have finally gotten what he wants out of Powell. In recent weeks, Trump has stepped up his attacks on the central bank, calling it the biggest problem facing the economy, floating the idea of firing Powell, and suggesting his administration would match China’s and Europe’s “currency manipulation game.”
Although many presidents before have pursued currency interventions and quibbled with Fed chairmen over interest rate policy, none have ever done it as openly and directly as the current one. Fed apologists in the media and in Congress view the central bank’s “independence” as being under assault.
The notion that the Fed ever was or could be independent of politics is a fanciful one. When a small group of people — appointed and confirmed by politicians — are empowered to make decisions that can make or break markets, economies, and elections, politics will inevitably intrude.
Fed chairman Jerome Powell may sincerely want to make monetary policy without regard to politics. But when political forces exert themselves on the Fed, he finds himself in an impossible catch-22. If he fails to cut rates, then the central bank risks becoming seen as the enemy of half the country as President Trump makes it his foil at campaign rallies. If Powell does what the President wants, then Democrats will accuse him of succumbing to political pressure from the White House.
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How to Destroy a Civilization
How to Destroy a Civilization
There are lots of ways to kill off a civilization. Wars, politics, economic collapse. But what are the actual mechanics? It might be a useful thing to know whether or not we are killing ourselves off.
Ancient Rome is a good place to start. They had an advanced civilization. They had running water, sewers, flush toilets, concrete, roads, bridges, dams, an international highway system, mechanical reapers, water-powered mills, public baths, soap, banking, commerce, free trade, a legal code, a court system, science, literature, and a republican system of government. And a strong army to enforce stability and peace (Pax Romana). It wasn’t perfect, but they were on their way to modernity.
One of my favorite quotes is from Marcus Tullius Cicero, statesman, orator and writer (106-43 BCE):
Times are bad. Children no longer obey their parents, and everyone is writing a book.
If that isn’t a mark of a civilized society I don’t know what is.
But Rome collapsed. I often wonder what would have happened if it hadn’t. Could we have avoided a thousand years of the Dark Ages. Could we have been flying airplanes and driving cars in the year 1000?
What the hell happened to Rome?
Dictators. After 500 years, the famous Roman Republic ended with the dictator Julius Caesar taking power. Four hundred years later his progeny and usurpers ran the Empire into the ground and Rome fell to invading barbarians.
The standard explanation for Rome’s decline and fall is that they devolved into dictatorships (true, but not the cause of their fall). Or they became decadent and corrupt (true, but not the cause of their fall). They fell to barbarian invasions (true, but not the cause of their fall).
Rome fell because the dictators ruined the Roman economy and the institutions that had made it prosperous. Rome was falling apart before the barbarian invasions.
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How Central-Bank Interest-Rate Policy Is Destabilizing Banks
How Central-Bank Interest-Rate Policy Is Destabilizing Banks
Broadly speaking, banks operate under the concept of maturity transformation. Banks take short-term – less than one year – financing vehicles, such as customer deposits, and use that to finance long-term – more than one year – returns. These returns range from the most commonly understood loans, such as auto loans and mortgages, to investments in equity, bonds and public debt. Banks make money on the interest spread between what they pay to the owners of the money and what is earned from the operations. Banks also make money on other services, such as wealth management and account fees, though these are relatively small compared to the maturity transformation business.
In terms of assets, the primary asset a bank holds is the demand deposit, also referred to as the core deposit. These are your everyday savings and checking accounts. Banks also sell Wholesale Deposits, such as CDs, have shareholder equity and also can take out debt, such as interbank lending. As these assets are owned by someone else, each of them demands a return for the use of those assets. These are part of the costs of operation for a bank. There are also more fixed operating costs, such as employees, buildings and equipment that must also be financed.
So, a bank will take assets and formulate loans on them. Like most of the world, the US operates on a fractional reserve system, one where banks originate loans in excess of the deposits on-hand. Take a look at the balance sheet of a large regional bank, 5/3 Bank, for example. For the 2018 fiscal year, 5/3 reported non-capital assets of $94 billion and a deposit base of $108 billion. However, the cash and cash equivalent component of these assets stood at $4.4 billion, or just 4% of demand deposits.
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ECB Inflationists are Crippling Europe
ECB Inflationists are Crippling Europe
Last week, the ECB announced the reintroduction of targeted long-term refinancing operations for the third time. TLTRO-III is scheduled to start from next September. The idea is to make yet more money available for the banks at attractive rates on condition they increase their lending to non-financial entities.
The policy is justified because the ECB sees growing signs the Eurozone economy is stalling, possibly badly. The weaker Eurozone economies are moving into outright recession, and Germany’s motor exports appear to have dramatically slowed, putting a constraint on her whole economy.
The ECB’s reintroduction of TLTRO is an offer of yet more monetary and credit inflation, despite the evidence that unprecedented waves of monetary inflation in the last ten years have failed in all the objectives for which they were designed, except two: governments have continued to get the funds to spend without meaningful restraint, and insolvent banks have been preserved.
Only two months after its asset purchase programme officially ended, the inflationists are at it again. But one wonders why the ECB bothers to delay TLTRO-III until September. If it is such a good thing, why not introduce it now?
There is another explanation, and that is the ECB is intellectually adrift with no economic compass. We do not know how many economists and monetary specialists are employed in the Eurosystem, which includes the ECB and the regional central banks, but they are certainly not economists, otherwise they would understand money. They may be technicians, which is not the same thing. If they were economists, or more precisely properly schooled in the human sub-science of catallactics (the theory of exchange ratios and prices) they would more fully appreciate the consequences of monetary inflation.
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Electoral College: Why We Must Decentralize Democracy
Electoral College: Why We Must Decentralize Democracy
Although it was long assumed that the electoral college favored Democrats — and this assumption continued right up to election night 2016 — Democrats in the United States have now decided the electoral college is a bad thing. Thus, we continue to see legislative efforts to do away with the electoral college, accompanied by claims that it’s undemocratic.
Not All Democracy Is Created Equal
In fact, the electoral college is neither more nor less democratic than the electoral college system. It’s unclear by what standard winning the presidency through 50 separate state-level elections is “less democratic” than winning one large national election.
What makes the electoral college different, however, is that it was born out of recognition that the interests, concerns, and values of voters can differ greatly from place to place. Moreover, the system anticipated the phenomenon in which people in large densely populated areas would have different political values from people in other areas. The electoral college was designed to make it less likely that voters from a single region — or small number of regions — could impose their will across the entire nation.
In contrast, one large national election — as envisioned by the critics of the electoral college system — could hand national rule over to a small number of cities and regions.
But even the electoral college system is too much slanted in favor of national politics and large majorities. Far better strategies for governance can be found Swiss democracy. Thanks to the presence of a multi-lingual, culturally diverse population, the creators of the Swiss confederation sought to ensure that no single linguistic, religious, or cultural group could impose its will nationwide. Thus, Swiss democracy includes a number of provisions requiring a “double majority.” That is, not only must an overall majority of Swiss voters approve certain measures, a majority of the voters in the majority of Swiss cantons must also approve.
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Can the EU Survive the Next Financial Crisis?
Can the EU Survive the Next Financial Crisis?
Despite the ECB’s subsidy of the Eurozone’s banking system, it remains in a sleepwalking state similar to the non-financial, non-crony-capitalist zombified economy. Gone are the heady days of investment banking. There is now a legacy of derivatives and regulators’ fines. Technology has made the over-extended branch network, typical of a European retail bank, a costly white elephant. The market for emptying bank buildings in the towns and villages throughout Europe must be dire, a source of under-provisioned losses. On top of this, the ECB’s interest rate policy has led to lending margins becoming paper-thin.
A negative deposit rate of 0.4% at the ECB has led to negative wholesale (Euribor) money market rates along the yield curve to at least 12 months. This has allowed French banks, for example, to fund Italian government bond positions, stripping out 33 basis points on a “riskless” one-year bond. It’s the peak of collapsed lending margins when even the hare-brained can see the risk is greater than the reward, whatever the regulator says. The entire yield curve is considerably lower than Italian risk implies it should be, given its existing debt obligations, with 10-year Italian government bonds yielding only 2.55%. That’s less than equivalent US Treasuries, the global risk-free standard.
Government bond yields have been and remain considerably reduced through the ECB’s interest rate suppression and its bond-buying programs. The expansion of Eurozone government debt since the Lehman crisis has been about 50% to €9.69 trillion. This expansion, representing €3.1 trillion, compares with the expansion of the Eurosystem’s own balance sheet of €2.8 trillion since 2009. In other words, the expansion of Eurozone government debt has been nearly matched by the ECB’s monetary creation.
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How Asset Inflation Will End — This Time
How Asset Inflation Will End — This Time
Life after death for asset inflation: this is what happens when “speculative fever” remains high even after monetary inflation has paused. This may well have been the situation in global markets during 2019 so far. But history and principle suggest that life after death in this monetary sense is short.
Readers may find it odd to be talking about a pause in monetary inflation at a time when the Fed has cancelled programmed rate rises and the ECB has embarked (March 7) on yet further “radical” policy moves. Moreover, the “core” US inflation rate (as measured by PCE) is still at virtually 2 per cent year-on-year.
Yet we know from past cycles that in the early stages of recession many market participants — and, crucially, central banks — mistakenly view a stall in rate rises or actual rate cuts as stimulatory. Later with the benefit of hindsight these policy moves turn out to be insufficient to prevent a tightening of monetary conditions already in process but unrecognized.
Even had monetary conditions been easing rather than tightening, it is highly dubious whether this difference would have meant the powerful momentum behind the business cycle moving into its recession phase would have lessened substantially.
(As a footnote here: under a gold standard regime there is no claim that monetary conditions will evolve perfectly in line with contracyclical fine-tuning. Both in principle and fact monetary conditions could tighten there at first as recessionary forces gathered. Under sound money, however, contracyclical forces would emerge strongly into the recession as directed by the invisible hand.)
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A Modest Proposal for the Fed
A Modest Proposal for the Fed
Quantitative easing, the program of asset buying initiated by the US Federal Reserve Bank in 2008, represents the most profound monetary experiment in the history of the world. Between fall of 2008 and fall of 2014, three successive rounds of QE quadrupled the monetary base of the world’s most-used and dominant currency, from less than $1 trillion to more than $4 trillion. The Fed literally created new money, bought Treasury debt and mortgage-backed debt (of dubious character) from commercial banks, and credited them with new reserves.
It was a great trick. If QE can be done without adverse effects or with few adverse effects, it represents nothing short of monetary alchemy (h/t Nomi Prins). Everything we thought we knew about the Fed as backstop lender of last resort to commercial banks, as hallway monitor of inflation and unemployment, is out the window.
If QE works, then every government on earth must take notice of the opportunity to effectively recapitalize their own banks and industries free of charge. QE turns central banks into kings of capital markets, into active participants in the economy. As one twitterati put it, expansionary QE created the biggest untold American story of the last twenty years: the Fed can now inflate and deflate assets, devalue savings, influence wages and productivity, encourage corporate malfeasance, and engineer balance sheets—all the while creating economic winners and losers.
What politician or central banker could resist?
Recall how defenders of QE not only argued it was necessary, but beneficial. Paul Krugman was among the worst offenders, insisting that low interest rates would mitigate any harms from such rapid monetary expansion. These defenders dismissed, and continue to dismiss, what is now obvious: since 2008 the US economy has experienced significant asset inflation in equity markets and certain housing markets, plus a creeping but steady rise in many consumer prices.
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The State Expands its Responsibilities In Order to Expand Its Power
The State Expands its Responsibilities In Order to Expand Its Power
Many moviegoers might recognize the following quotation: “with great power comes great responsibility.”
Reality, however, is the exact opposite of what the quote describes. In reality, it is responsibility that precedes power. In a corporation, for instance, when you’re hired you are told your responsibilities and the powers granted to you are those that are necessary for you to accomplish your responsibility.
In John’s family, John’s father demands that everyone stay out of the kitchen while he cooks, lest they distract him. It is not because John’s father has the power to keep everyone out of the kitchen that he has accepted the responsibility of cooking; it is because he is responsible for cooking that he has the power to keep everyone out of the kitchen.
A vast number of self-help books focus on self-responsibility. This is no coincidence. It is only by accepting responsibility for our lives that we can acquire power over our lives. On the other hand, by blaming others for our conditions, we forfeit our responsibility, and consequently, our power.
Responsibility is important not just because it provides power but also because, as psychologist Jordan Peterson has often remarked, most people find the meaning of their lives through responsibility.
Examining American history, it is evident that the expansion of government powers has been a direct result of the government’s theft of the responsibilities of the individual.
There is a rather straightforward argument that is consistently presented by the government in order to justify its theft of responsibilities that rightfully belong to others.
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The Pseudo-Psychology Behind Monetary Policy
The Pseudo-Psychology Behind Monetary Policy
In his various writings, the champion of the monetarist school, Milton Friedman, argued that there is a variable time lag between changes in money supply and its effect on real output and prices. Friedman holds that in the short run changes in money supply will be followed by changes in real output.
However, in the long-run changes in money will only have an effect on prices. All this means that changes in money with respect to real economic activity tend to be neutral in the long-run and non-neutral in the short-run. Thus according to Friedman,
In the short-run, which may be as much as five or ten years, monetary changes affect primarily output. Over decades, on the other hand, the rate of monetary growth affects primarily prices.1
According to Friedman because of the difference in the time lag, the effect of the change in money supply shows up first in output and hardly at all in prices. It is only after a longer time lag that changes in money start to have an effect on prices. This is the reason according to Friedman why in the short-run money can grow the economy, while in the long run it has no effect on the real output.
According to Friedman, the main reason for the non-neutrality of money in the short-run is the variability in the time lag between money and the economy.
Consequently, he believes that if the central bank were to follow a constant money growth rate rule this would eliminate fluctuations caused by variable changes in the money supply growth rate. The constant money growth rate rule could also make money neutral in the short-run and the only effect that money would have is on general prices in the long run.
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How the Euro Enabled Europe’s Debt Bubbles
How the Euro Enabled Europe’s Debt Bubbles
It’s the twentieth anniversary of the euro’s existence, and far from being celebrated, it is being blamed for many — if not all — of the Eurozone’s ills.
However, the euro cannot be blamed for the monetary and policy failures of the ECB, national central banks and politicians. It is just a fiat currency, like all the others, only with a different provenance. All fiat currencies owe their function as a medium of exchange from the faith its users have in it. But unlike other currencies in their respective jurisdictions, the euro has become a talisman for monetary and economic failures in the European Union.
The Birth of the Euro
To swap a number of existing currencies for a wholly new currency requires the users to accept that the purchasing powers of the old will be transferred to the new. This was not going to be a certainty, and the greatest reservations would come from the people of Germany. Germans saved, and therefore risked the security of their deposits in a new money and monetary system. They were reassured by the presence of the hard-money men in the Bundesbank, who had a mission to protect the mark’s characteristics against the weaknesses that would almost certainly be transferred into the new euro from more inflationary currencies.
These anxieties were assuaged to a degree by establishing the ECB in Frankfurt, close to the watchful eye of the Bundesbank. The other nations were sold the project as bringing greater monetary stability than offered by their individual currencies and the reduction of cross-border transaction costs. Borrowers in formally inflationary currencies also relished the prospect of lower interest rates.
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France’s Protests: Why It’s Different This Time
France’s Protests: Why It’s Different This Time
When the first demonstrations on the streets of Paris were reported nine weeks ago, nobody could have foreseen the endurance, the tenacity and the viral effect of the Yellow Vests movement. After all, the French are known to protest and to strike, it’s part and parcel of their culture. However, by the time this article is being written, protests, marches and demonstrations have broken out in a multitude of European cities.
Why Was it Different this Time?
To begin with, it is worth taking a closer look at the situation in France, the point of origin of this “contagion.” There are a few very important elements that set the Yellow Vests apart from past protests. For one thing, unlike previous demonstrations, this one wasn’t led by the unions, nor was it organized by any identifiable political body. The protesters had no unified or homogenous political beliefs, party affiliations or ideological motivations. In fact, through interviews and public statements of individuals taking part in the demonstrations, it would appear that any organized elements, or members of the far-left or the far-right were a slim minority among the protesters. And while those few were the ones largely involved in the violent clashes with the police and the destruction of private and public property, the crushing majority of the Yellow Vests were peaceful, non-violent and largely unaffiliated with any particular political direction.
As the movement grew and spread, many political figures have tried to co-opt it, without success. Front National’s Le Pen, hardline leftist Melenchon, far-left factions and various union leaders, all tried to place their flag on the Yellow Vests, claiming that they align with and can represent their grievances. They all failed.
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Fire the Fed?
Fire the Fed?
President Trump’s frustration with the Federal Reserve’s (minuscule) interest rate increases that he blames for the downturn in the stock market has reportedly led him to inquire if he has the authority to remove Fed Chairman Jerome Powell. Chairman Powell has stated that he would not comply with a presidential request for his resignation, meaning President Trump would have to fire Powell if Trump was serious about removing him.
The law creating the Federal Reserve gives the president power to remove members of the Federal Reserve Board — including the chairman — “for cause.” The law is silent on what does, and does not, constitute a justifiable cause for removal. So, President Trump may be able to fire Powell for not tailoring monetary policy to the president’s liking.
By firing Powell, President Trump would once and for all dispel the myth that the Federal Reserve is free from political interference. All modern presidents have tried to influence the Federal Reserve’s policies. Is Trump’s threatening to fire Powell worse than President Lyndon Johnson shoving a Fed chairman against a wall after the Federal Reserve increased interest rates? Or worse than President Carter “promoting” an uncooperative Fed chairman to Treasury secretary?
Yet, until President Trump began attacking the Fed on Twitter, the only individuals expressing concerns about political interference with the Federal Reserve in recent years were those claiming the Audit the Fed bill politicizes monetary policy. The truth is that the audit bill, which was recently reintroduced in the House of Representatives by Rep. Thomas Massie (R-KY) and will soon be reintroduced in the Senate by Sen. Rand Paul (R-KY), does not in any way expand Congress’ authority over the Fed. The bill simply authorizes the General Accountability Office to perform a full audit of the Fed’s conduct of monetary policy, including the Fed’s dealings with Wall Street and foreign central banks and governments.
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Behind the Scenes at the Central Banks that Created our Modern Monetary System
Behind the Scenes at the Central Banks that Created our Modern Monetary System
[From the Summer 2018 Quarterly Journal of Austrian Economics. A review of How Global Currencies Work: Past, Present, and Future by Barry Eichengreen, Arnaud Mehl, and Livia Chitu, Princeton, N.J.: Princeton University Press, 2018, 250 pp.]
The present volume is an engaging and intriguing account of how global currencies, such as British sterling and the U.S. dollar, have risen to global dominance in the international monetary arena, and how currencies such as the Chinese renminbi, for example, could follow in their footsteps. Divided into twelve chapters, the work focuses primarily on the international monetary history of the 20th century, complemented by a comparatively brief account of the 19th and 21st centuries. The narrower focus of the discussion in these chapters—and most of the data supplied in each chapter’s appendices—concerns the composition of foreign reserves, i.e. the balance between holdings of pounds and dollars, and later of yen, euro, and renminbi.
From this, the authors propose to tease out a few new factual discoveries and some implications for the future of the international monetary system. More precisely, they disavow the traditional theoretical view which argues that international currency status resembles a natural monopoly that arises organically from the benefits of using the currency of the most economically (commercially and financially) powerful country in international economic transactions, i.e. a monopoly due to network returns (p. 4), and winner-takes-all and lock-in effects.
Because, argue the authors, this ‘old’ model is not supported by much of the data from the 20th century, they propose a ‘new’ view arguing that multiple currencies can be used concomitantly on an international scale, such as the pound sterling and the dollar during the 1920s. These currencies played “consequential international roles” (p. 11) demonstrating that inertia and persistence due to network effects in international transactions are not as strong as previously thought.
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