How Trump Bailed Out Janet Yellen and the Federal Reserve — For Now
Questions Remain as the Fed Finally Begins to Reverse QE
Money-Supply Growth Drops Again — Falls to 108-Month Low
Why Is the Euro Still Gaining Against the Dollar?
The primary purposes of the incorrectly named “unconventional monetary policies” are to debase the currency, stoke inflation, and make exports more competitive. Printing money aims to solve structural imbalances by making currencies weaker.
In this race to zero in global currency wars, central banks today are “printing” more than $200 billion per month despite that the financial crisis passed a long time ago.
Currency wars are those that no one admits to waging, but everyone wants to fight in secret. The goal is to promote exports at the expense of trading partners.
Reality shows currency wars do not work, as imports become more expensive and other open economies become more competitive through technology. But central banks still like weak currencies — they help to avoid hard reform choices and create a transfer of wealth from savers to debtors.
The Euro Rallies
So how must the bureaucrats at the European Central Bank (ECB) feel when they see the euro rise against the U.S. dollar and all its main trading currencies by more than 12 percent in a year, despite all the talk about more easing? The ECB will keep buying 60 billion euro a month in bonds, maintain its zero interest-rate policy, and keep this “stimulus” as long as it takes, until inflation growth and GDP growth are stable.
Contrary to the wishes of the ECB, however, a strong euro is justified for several reasons. First, the European Union’s trade surplus is at record highs, and 75 percent of Eurozone trade happens between eurozone countries. Higher exports and the continued recovery of internal demand in European member countries strengthen the euro.
The third is the perception of weakness of the U.S. government and its inability to push through key reforms. This has weakened the dollar and by definition strengthened the other two large trading currencies, the euro and the Japanese yen.The second important factor is the relief rally after the French and Dutch elections. The fears of a euro breakup have been eliminated, or at least delayed, as pro-EU political parties won.
The Problems With a Strong Euro
However, a strong euro has very significant implications for the EU economy and the ECB’s policy.
The strong euro puts exports to its main outside trading partners — the United States (20.8 percent of exports in 2016) and China (9.7 percent) — at risk. Despite the ECB’s extreme monetary policy and a euro trading almost at parity with the dollar, exports to non-EU countries have stalled since 2013. GDP growth estimates for 2018 are falling due to a lower contribution of net exports.
The currency also has a high impact on tax revenues in Europe. The correlation between the euro–dollar exchange rate and the earnings estimates of the largest multinationals represented in the Stoxx Europe 600 Index is very high.
According to our estimates, a 10 percent rise of the euro against the dollar is equivalent to an 8 percent drop in earnings and leads to lower corporate tax revenues. From an investment perspective, as earnings drop, the European stock market goes from being relatively cheaper to becoming more expensive.
Investors and economists need to pay attention to these factors. If the euro continues to strengthen, the EU economic recovery is at risk. So the eurozone is stuck between a rock and a hard place. It cannot stop the stimulus because deficit spending governments cannot live with higher financing costs, and increasing the stimulus to weaken the currency simply doesn’t work anymore.
The only way out is structural reforms, but most governments are afraid of them even in good times, let alone when the going gets tough.
Originally published by Epoch Times. Reprinted with permission.
Stanley Fischer’s Well-Timed Fed Exit
Fed vice-chair Stanley Fischer’s surprise announcement of early retirement triggers the obvious question as to whether this could be the fore-runner to a serious market and economic deterioration ahead. Monetary bureaucrats, even if signally bad at counter-cyclical fine tuning, sometimes have a reputation for intuition about how to time their own career moves ahead of crisis. In this case, such suspicion may be wide of the mark given the personal circumstances. Even so, the exit of a Fed Vice-Chair, who in many respects has been the pioneer and the dean of the prevailing doctrine in the global central bankers club, is pause for thought.
The Early Years
When Professor Fischer published his famous paper “On Activist Monetary Policy with Rational Expectations” (NBER working paper no. 341, April 1979), the fiat money world was well into the third stage of disorder following the collapse of the international gold standard in 1914. But things were at a temporary resting point where the skies seemed to be getting clearer. After the violent terminal storms of the gold exchange standard (early 20s to early 30s), and then of the Bretton Woods System, it seemed to many that the “monetarist revolutionaries” had found a better practical monetary navigation route. The Bundesbank, the Federal Reserve, the Swiss National Bank, and even the Bank of Japan were pursuing an ersatz gold rule of low percentage increases in the monetary base or a related aggregate.
Fischer vs. the Monetarists
Despite the optimism at large, Fischer issued a challenge. The monetarist rules (x per cent growth of the chosen monetary aggregate) were doomed to fail when the underlying demand for money and monetary base in particular was so unstable.
Fischer rejected the new popular view (in the late 1970s) of the fashionable “classical economists” (for example Robert Barro) who argued that under market rationality monetary policy was powerless to influence the real economy. All the various trade-offs hypothesized by the Keynesian economists of the previous decade and pursued in part had been based on a view that central bankers could take the public by surprise (who would not realize what they were “up to” until later on). But once the public knew all Keynesian manipulations could not be effective.
In contrast, Fischer purported to demonstrate that if wages were rigid (most likely due to the existence of long-term contracts), then even given rational expectations, monetary policy could stimulate the real economy.
And so Professor Fischer, on the basis of his pioneering neo-Keynesian creed, preached that, yes, central bankers could and should pursue activist contra-cyclical strategies, especially when shocks were large and obvious. But yes, he also recognized that fine-tuning had its dangers and could morph into a long-run rising inflation rate, and so he recommended that policy be bound by the setting of a low inflation target. These ideas were in turn taken up and worked on by leading disciples (students) of Stanley Fischer, including Ben Bernanke and Mario Draghi.
The Birth of the 2% Inflation Standard
And so the fourth stage of fiat money disorder was born — what we may describe as the “global 2% inflation standard”. The prior monetarist experiments faded away in the decade following publication of Fischer’s paper (Paul Volcker abandoned monetarism by 1982, and the Bundesbank was the last hold-out in the year before the launch of the euro). At a stretch we could call this fourth stage the “Fischerian age of monetary policy”. Even though its author is now retiring, the outlook is for this stage to move eventually into a much more vicious sub-stage in which inflation rises far above the levels which the central bankers are purporting to target and the forces of rationality greeted by the classical revivalists have been completely trumped by powerful irrational forces which typify asset price inflation..
And all of this does not depend on who exactly President Trump decides to nominate in Fischer’s and Yellen’s place in coming months, even though there are reasons to speculate that the choice is likely to be pro-3% growth with the near-term target of avoiding defeat in next year’s mid-term elections. The bigger issue is that the so-called 2% inflation target belongs to a collection of fables under the title of the Emperor’s New Clothes. In today’s monetary environment where monetary base has been totally dislocated from the pivot of the monetary system (e.g., there's no stable demand, distinctive qualities of base money are virtually eradicated, and both supply and demand are boated by QE) there is no basis – other than expectation inertia – to view prices of goods and services as anchored.
At the best of times no one knew the precise relationship between monetary aggregates and prices — and indeed under the gold standard or monetarism no one pretended to have the price path under control; at best money was under control and that should foster some long-run tendency for prices to return to the mean, but there was no assurance of this. Strikingly the “Fischerians” have lost all sight of the natural rhythm of prices as responding to fluctuations in the pace of globalization, productivity growth, and of course the business cycle.
There is every reason to believe that expectation inertia will snap at some point in the future. And the root combination of monetary disorder — a Federal budget deficit of 4-5-6% of GDP at a cyclical peak, a Federal Reserve determined to hold down rates and manage the government bond markets, an administration favoring a weak dollar — there are grounds for fearing a lurch of the monetary train towards high inflation, albeit possibly beyond the next business cycle trough. And all of that despite the pride of Stanley Fischer in his resignation letter to President Trump:
During my time on the Board, the economy has continued to strengthen, providing millions of additional jobs for working Americans. Informed by the lessons of the recent financial ciris, we have buildt upon earlier steps to make the financial system stronger and more resilient and better able to provide the credit so vital to the prosperity of our country’s households and businesses.
Power corrupts, and Washington corrupts absolutely. How can anyone pretend to have learnt the lessons and achieved the results until at least one long business cycle under the given monetary regime has been completed? Only then can all the mal-investment be counted and the financial quake or hurricane damage assessed.
Trump's Historic Opportunity with the Federal Reserve
And then there were three.
Today Stanley Fischer submitted his letter of resignation from the Federal Reserve’s Board of Governors, effective next month, the second such resignation of Donald Trump’s presidency. While Fischer’s term as Vice Chairman of the Fed was set to end next year, he had the ability to serve as a governor through 2020. Along with Trump’s decision next year on whether to replace Janet Yellen as the Fed’s chair, this means Trumps will have the opportunity to appoint five of seven governors to America’s central bank.
Given that the position holds a 14-year term, it is unusual for a president to have the opportunity to make so many appointments. As Diane Swonk of DS Economics noted, “It’s the largest potential regime change in the leadership of the Fed since 1936.”
Of course the question is now whether a change in personnel will lead to a change in policy.
Trump has already taken steps to fill one of the vacancies, nominating Randal Quarles earlier this year. Quarles, a former Bush-era Treasury official turned investment banker, will be taking the specific role of Fed vice chair of supervision. As a vocal critic of Dodd-Frank, and the Volker Rule in particular, Quarles may help relieve some of the regulatory burden on financial institutions, but his views on monetary policy are less clear. He has also voiced his support for rules-based monetary policy, though he has distanced himself to the specific proposal of the “Taylor Rule.” Given the growing consensus building for NGDP-targeting, and Republicans in Congress advocating for rules-based Fed reform, Quarles could become a supporter from within the central bank. All in all though, Quarles is seen by many observes as a bland Fed-appointment.
More concerning are the views of Marvin Goodfriend, who has been reported to be a front runner for one of the Fed vacancies. An economics professor at Carnegie Mellon University and former director of research at the Richmond Fed, Goodfriend has a traditional central banker background and the dangers that comes with it. In 2016, Goodfriend made an impassioned plea for the Fed to consider negative-interest rates:
The zero interest bound is an encumbrance on monetary policy to be removed, much as the gold standard and the fixed foreign exchange rate encumbrances were removed, to free the price level from the destabilizing influence of a relative price over which monetary policy has little control—in this case, so movements in the intertemporal terms of trade can be reflected fully in interest rate policy to stabilize employment and inflation over the business cycle.
Since negative interest rates usually coincide with greater use of cash (and personal vaults), Goodfriend went so far as to suggest the Fed should consider devaluing the value of printed bank notes. A $10 bill would buy less than a $10 debit card transaction, opening up a new front in the ongoing war on cash.
Given his radical views on monetary policy, it’s not hyperbole to suggest that Goodfriend’s nomination would represent a genuine danger to the economic wellbeing of every American citizen – or at least those outside of the financial services industry.
Unfortunately, even if Goodfriend doesn’t get the nod, it’s unlikely Trump will nominate anyone who understands the negative consequences of our artificially low interest rate environment. Though Candidate Trump demonstrated remarkable savvy when it came to how the actions of Bernanke and Yellen hurt Americans, as President Trump he has consistently indicated a desire to keep the “big fat bubble” going. Such a desire obviously fits the self-interest of the White House, but with long-term consequences for the base that elected him.
The only hope for a change in direction from the Administration is for Trump to stop listening to his Goldman Guys and instead lean on the team that helped get him to the White House. As Tommy Behkne noted last November, Trump had managed to surround himself with a number of Fed skeptics during his campaign, and even considered Austrian-friendly John Allison for Treasury Secretary.
Given the historic opportunity he has with the Fed, if Trump chooses to return to those roots, he could do severe damage to the swamp — all without passing a single piece of legislation through Congress.
Stanley Fischer Is Out at the Fed
Fed Vice Chair and Yellen ally Stanely Fischer announced his unexpected resignation today, citing “personal reasons.” His term as a Fed governor wasn’t to be over until 2020 and his vice chairmanship was to end June of next year.
Fischer was one of the three most important Fed members, the other two being Yellen herself and the New York Fed’s William Dudley. The WSJ reports:
Mr. Fischer came to the Fed in 2014 a luminary in central banking, having taught many leading policy makers during a more-than two decade career as a professor at the Massachusetts Institute of Technology specializing in international economics. His students included European Central Bank President Mario Draghi and former Fed Chairman Ben Bernanke.
Mr. Fischer also ran a central bank—the Bank of Israel—from 2005 to 2013, held a senior post at the International Monetary Fund and served as a Citigroup vice chairman.
In terms of the insider status of these central bankers, Mr. Fischer was “Mr. Establishment.” Well educated in the machinations of how to control an economy from the top, Fischer was an expert bureaucrat. On paper, Fischer was among the most qualified in the world to be tasked with impossible role of making us more prosperous by diktat.
In reality, Fischer, to the extent he had a marked influence on central bankers like Draghi, Bernanke, Yellen, and so many others, was a key player in the boom-and-bust system of modern monetary economics. Under his watch, we had two major and devastating recessions— the cause of which was not Fischer’s failure individually, but the inflationary framework that pervades them all.
Fischer was considered to have leaned “hawkish” by the financial press. In the old days of Paul Volcker, a hawk was one wary of dangers of rising inflation. This was juxtaposed to a dove, who would downplay the dangers of inflation and advise greater monetary expansion. But in the post-crisis era of the so-called “new normal,” where interest rates are to remain absurdly low and inflation must be targeted at 2%, the hawks have long gone extinct. Fischer was no hawk, he was a cheerleader of the quadrupling of the Fed’s balance sheet, an advocate of unprecedented credit creation, and a hater of sound money.
It remains to be seen where Fischer will go next. But his undying advocacy of the use of central banking to tinker with and manage the economy will live on.
- "The Fed Wants to Test Drive Negative Interest Rates" by Joseph Salerno
- "Stanley Fischer's Eureka Moment" by C.Jay Engel
Bank of Canada Raises Interest Rates … Again
Bank of Mexico: Bread Today, Hunger Tomorrow
A History of the Fed's Political Power
The Power and Independence of the Federal Reserve
Princeton University Press, 2016
xiv + 347 pages
Peter Conti-Brown, a legal historian who teaches at the Wharton School, would sharply dissent from Ron Paul’s wish to End the Fed. He never cites Mises or Rothbard, and the only Austrian work that he mentions, hidden away in an endnote, is Vera Smith’s The Rationale of Central Banking and the Free Banking Alternative. Nevertheless, Austrians will find Conti-Brown’s book of great value. He has, with considerable scholarship, exposed many grave problems with the Fed in a way that strengthens and supports the anti-Fed case.
The paramount concern of Austrian criticism of the Fed has been the vital role of that organization in expanding the money supply. Doing this, as the Austrian theory of the business cycle explains, drives the money rate of interest below the “natural” rate, primarily determined by people’s rate of time preference. This leads to an artificial boom and eventually proves unsustainable, resulting in a depression. Murray Rothbard classically applied this analysis in America’s Great Depression (1963), which emphasized the expansionary monetary policy of the 1920s, pursued by the Fed at the behest of Benjamin Strong, the Governor of the Federal Reserve Bank of New York, in causing the 1929 crash.
Conti-Brown tells us that this view of the Fed’s role in the 1920s was shared by none other than Herbert Hoover, who figures in Rothbard’s book as a principal villain for his futile interventionist efforts to cope with the depression. Hoover “blamed the Fed generally (and the New York Fed in particular) for causing the Great Depression. This orgy [of speculation] was not a consequence of my administrative policies, he wrote, but of the ‘mediocrities’ at the Fed” (p. 24). “Hoover further complained that the Fed (under Benjamin Strong) turned American optimism into ‘the stock-exchange Mississippi Bubble’ ” (p. 283, note 19).
The Fed continued its expansionary course during the 1930s, and here the influence of the banker Marriner Eccles was paramount. Eccles shaped the modern Fed through proposals that Congress enacted in the Banking Act of 1935, which “abolished the Federal Reserve Board created in 1913 and replaced it with the Board of Governors of the Federal Reserve System”(p. 27). Once ensconced in power at the Fed, “Eccles’s clear policy ... was to use all policy instruments at the government’s disposal to do for the economy what consumers could not do: spend their way out of the depression” (p. 32). Eccles greatly admired Franklin Roosevelt and was careful to coordinate his policies with him. “ ‘Coordinate’ may even suggest more separation than Eccles intended: he meant for monetary policy to be administration policy” (p. 32). His ideas resembled those of Keynes, but Eccles had developed them independently. “Though they had never met, the millionaire Mormon from Utah had anticipated the dapper Cambridge don’s worldview” (p. 26). Eccles and Keynes eventually met at Bretton Woods in 1994 but did not like each other.
Conti-Brown, as we will see, views such policies with favor; but he aptly describes the consequences of a monetary expansion that fails: “What looks like economic growth is, in fact, a monetary mirage. It’s not more jobs, goods, and services that we see; it’s just more money. And when more and more money chases the same (or shrinking) number of jobs, goods, and services, the prices of everything go up. These inflationary pressures threaten to undermine the economy’s stability and consumer confidence in the level of prices and wages” (p. 133).
If we turn from the 1930s to the recent past, we find that the Fed has continued on its reckless ways. After the Panic of 2008, Fed Chairman Bernanke assumed extreme power to meddle in the economy. “Invoking emergency lending authority that had been unused for almost eighty years, the Fed picked up its ‘lender-of-last-resort’ function and proceeded to deploy it throughout the economy ... [this] started with the investment banking giant Bear Stearns and in time extended to money market funds, traditional banks, and insurance companies” (pp. 154–55).
The extent of the Fed’s power to intervene is difficult to fathom. “When Bernanke and Secretary of the treasury Henry Paulson approached Congress in the fall of 2008 about the need to inject $85 billion into the insurance giant AIG, [Barney] Frank asked if the Fed had that kind of money. Bernanke responded that he had $800 billion. Frank was stunned. ‘He can make any loan he wants under any terms to any entity or individual in America that he thinks is economically justified’ ” (p. 155).
The Fed under Bernanke did not confine itself to aiding particular firms but aimed at a general monetary expansion. His policy came as no surprise. “In one speech in 2002, Bernanke, then a member of the Fed’s Board of Governors (but not the chair), alluded to a helicopter drop of cash on the general public as a way of getting growth and inflation back to desirable levels. In light of subsequent events, and with that precedent in mind, his critics have sometimes called him ‘Helicopter Ben’ ” (p. 143).
Once he became Chair, Bernanke followed through in a bizarre fashion, in what was called “forward guidance.” This “binds the central bank to a mast of its own in an eff ort to convince participants in the economy that the Fed will honor its policy for a certain period of time. ... [T]he central bank must commit that its monetary policy ‘will in fact be effective if the central bank can credibly promise to be irresponsible, to seek a higher future price level’ ” (p. 143, quoting Paul Krugman).
By no means does this exhaust the material a critic of the Fed can draw from Conti-Brown’s book. He points out that the Fed finances its own activities by issuing money: it is not dependent on Congressional appropriations to keep it going. “That the Fed funds itself largely from the proceeds of its substantial assets, taken together with the nature of the Fed’s ability to create money in pursuit of its monetary policy objectives, means that the Fed’s funding is unique in government. ... [T]he Fed conducts monetary policy by, among other options, creating money with which it can buy government — and more recently, nongovernment securities. These interest-bearing assets generate money that the agency can subsequently use to fund itself ” (p. 207).
If the Fed is an arbitrary and irresponsible agency in the fashion so far described, is there not an excellent case for doing away with it? Conti-Brown does not agree at all. He fears the “devastation of expected deflation” (p. 143) that might ensue were the economy on a strict gold standard and thus largely supports Bernanke’s policies.
Conti-Brown’s focus differs entirely from criticism of monetary expansion. He believes that critics of the Fed are in a grip of a false picture of how it operates, which he calls the Ulysses/ punch bowl view. “Ulysses” refers to the incident in The Odyssey in which Ulysses had himself tied to the mast of a ship so he could hear the sirens’ song; and the “punch bowl” to a comment by Fed Chairman William McChesney Martin that the Fed’s role was to withdraw the punch bowl when the party was getting interesting. “The subjects of the metaphors differ by millennia, but the idea is the same: the partygoers and Ulysses alike want something in the near term that their best selves know is bad for them in the long term. Central bank independence is the solution” (p. 3). Conti-Brown maintains that this view rests on an oversimplified view of how the Fed operates, and that “independence” is not an analytically useful concept in understanding the Fed. He may well be right on both counts; but although he repeats the metaphor interminably, he has not at all made his case that the bulk of criticism of the Fed rests on acceptance of the misleading picture he condemns. To confront criticism of the sort advanced by Ron Paul and Rothbard, Conti-Brown would have to respond to Austrian monetary theory. He instead bypasses monetary theory almost entirely, a great pity owing to his gifts of clear exposition. To do this in a book about the Fed is to offer us Hamlet without the Danish prince.