Interviewed by host Tom Woods, Joe Salerno talks about the Fed, the Great Depression, currency wars, deflation, and why governments hate cash.
Interviewed by host Tom Woods, Joe Salerno talks about the Fed, the Great Depression, currency wars, deflation, and why governments hate cash.
Noah, commenting on “For More Jobs and Stability, Set the Economy Free”, points to second important observation in the linked commentary by Kevin Warsh – the spillover effect of Fed Policy, with significantly negative long run consequences, on the world economy. From his comment:
The piece by Kevin Warsh that was linked in the article (“Finding Out Where Janet Yellen Stands”) included this important observation:
“The Fed makes domestic decisions for the domestic economy. Yes, but the U.S. is the linchpin of an integrated global economy. Fed-induced liquidity spreads to the rest of the world through trade and banking channels, capital and investment flows, and financial-market arbitrage. Aggressive easing by the Fed can be contagious, inclining other central banks to ease as well to stay competitive. The privilege of having the dollar as the world’s reserve currency demands a broad view of global economic and financial-market developments. Otherwise, this privilege could be squandered.”
The Fed is not just picking winners and losers domestically, it is doing so globally. While the winners fill their pockets, the losers get increasingly restless and increasing aware that the screwing they are getting is not random but has a very definite source.
As is often the case, Austrian influenced economists have been on the leading edge. Those wonkish types interested more detail first see the Fertig Prize winning article Monetary Nationalism and International Economic Stability by Andreas Hoffmann and Gunther Schnabl. The abstract:
ABSTRACT: This paper describes the international transmission of boom-and-bust cycles to small periphery economies as the outcome of excessive liquidity supply in large center economies, based on the credit cycle theories of Hayek, Mises, and Minsky. We show how too-expansionary monetary policies can cause overinvestment cycles and distortions in the economic structure on both the national and the international level. Feedback effects of crises in periphery countries on center countries trigger new rounds of monetary expansion in center countries, which bring about new credit booms and international distortions. Crisis and contagion in globalized goods and financial markets indicate the limits of purely national monetary policies in countries, which provide the asymmetric world monetary system with an international currency. This makes the case for a monetary policy in large countries that takes responsibility for its long-term effects on goods and financial markets in both the center and the periphery countries of the world monetary system.
Other good work on the topic is by Metro State’s Nicolas Cachanosky:
“U. S. Monetary Policy’s Impact on Latin America’s Structure of Production (1960-2010)” which extends ABCT and capital-based macroeconomics in the international arena, especially as it applies to the ‘periphery’.
I study the effects of U.S. monetary policy on Latin America’s structure of production prior to two recent economic crises. I find that changes in the Federal Funds rate produced uneven effects across economic sectors. Those industries that are more capital intensive and relative long-term projects are more sensitive to changes in the Federal Funds rate than projects that are less capital intensive and relative short-term in duration. Therefore, periods of loose monetary policy resulted in a misallocation of resources that has been costly to correct during the bust. This result finds a particular pattern of economic distortion during an unsustainable boom.
Also by Andreas Hoffmann’s “Zero Interest Rate Policy and the Unintended Consequences on Emerging Markets.”
In response to the subprime crisis and Great Recession central banks in advanced economies have cut interest rates towards zero and increased monetary accommodation to step-up domestic growth. In this paper I attempt to describe the unintended consequences of the low interest rate policies in emerging markets. I argue based on the Mises-Hayek business cycle theory that the current low interest rate policy in advanced economies may have planted the seeds for new bubbles and gave rise to interventionist cycles in emerging markets. I show that capital flows to high-yielding emerging markets translate into monetary expansion in emerging markets. In the face of buoyant capital inflows fear of floating forces emerging markets to follow the interest rate policy of advanced economies. The monetary expansion triggers mal-investment and over-borrowing. To stem against arising inflationary pressure and kill-off speculative capital inflows empirical evidence suggests that emerging market governments increasingly repress financial markets. International financial markets disintegrate. I conclude that the monetary policy of the large advanced economies is incompatible with financial integration and globalization
It was a clear violation of Section 14 (B) of the Federal Reserve Act for the Fed to respond to the Crash of 2008 by buying $1.5 trillion of mortgages not guaranteed by the federal government. The agency hid behind Section 13.3 language allowing a broad scope of action under “unusual and exigent circumstances,” but the statute states clearly that Section 13.3 loans can only be short term and backed by high quality collateral, a requirement that was blatantly ignored.
It was also a violation of both the Fed statute and the Constitution to offload potential Fed losses from its hedge fund-like operations onto the Treasury, as was done stealthily via a note to the Fed’s Statistical Release H 4.1 dated January 6, 2011. The notion of the Treasury (i.e. The taxpayers) having to bail out the Fed is not just a theoretical possibility. The Fed’s annual report just released shows a $53 billion unrealized loss.
It would also appear to be a violation of the Constitution to locate the new Consumer Financial Protection Bureau created by the Dodd-Frank Act inside the agency. The Constitution requires that all government expenditures be authorized and funded by Congress. The Fed has always been treated as an exception. It uses income on securities it has bought with newly created money to pay its bills and has not even been subject to Congressional oversight.
Having a secretive, self-funded, extra-constitutional agency inside government was bad enough when the Fed consisted of seven governors and a few staff members. The new Consumer Bureau already employs an estimated 1,359 people and keeps growing. Many of these employees were transferred from other government agencies where they formerly had been counted as part of the federal budget, but are now suddenly off-budget. If this is allowed to stand, what other federal agencies will be slipped inside the Fed in future in order to reduce the reported Federal deficit?
Some of the Fed’s actions since the Crash have been perfectly legal, but also designed to escape detection by the press and public. For example, in the dark days of the 2008 crash, a provision was buried deep in the TARP bill passed by Congress authorizing the Fed to pay interest to banks on their lending reserves. This made it legal for the Fed to print money and hand it over to the banks in unlimited amounts. One wonders how many members of Congress were aware they were passing this?
Today the Fed pays ¼ of 1 percent interest on trillions of dollars of unused bank reserves. An estimated 37% of that is paid to foreign banks. This is a grey area legally. One wonders how many members of Congress know about it.
During the Crash itself, as much as 70% of Fed discount window loans seem to have gone to foreign banks at rates as low as 0.01%. In other words, we made huge gifts to foreign banks.
If the economy gets overheated, the Fed says that it will simply increase the interest it is paying on bank reserves to ensure that those reserves aren’t turned into loans to business and consumers. But the more money that is created to pay interest on unused reserves, the bigger the unused reserves become. In typical government style, a problem will be alleviated short term only at the cost of making it worse in the future.
After reading this post, you might conclude that someone should sue the Fed over its illegal actions. Unfortunately taking the Fed to court is easier said than done. Under federal law, you must have “standing” to sue. Ordinary citizens are deemed not to have standing. Under recent court decisions, even banks do not seem to have standing, despite their being regulated by the Fed.
Fed illegality can best be addressed by Congressional action. Congress created the Fed and can reform it or even shut it down. There are critics of the Fed in Congress, but not nearly enough of them. And there are reasons why Congress mostly leaves the Fed alone.
It is the Fed that backstops federal deficit spending. Without the Fed, government could not continue indefinitely spending more than its tax revenue. So long as politicians think they benefit from the expansion of government and runaway spending, they will not want to reform the Fed.
Following the Fed meeting last week, I was interviewed by Thomas Ressler, editor of Inside the CFPB (Published by Inside Mortgage Finance Publications) focusing on the impact of Fed policy on MBS and the housing market.
His summary of our discussion:
More broadly speaking, Fed watcher John Cochran, emeritus professor of economics at Metropolitan State University of Denver, agreed that one of the first things that needs to happen to attract private capital back into the MBS market is for the Fed’s footprint in the space to shrink. However, given the drop-off in new issuance, the Fed’s share of the pie may actually be increasing.
It’s true that the Fed is reducing its purchases somewhat, but “the trend seems to show that they’re buying a larger and larger percentage of total new securities issued,” Cochran said. “So I’m not really certain when and how private money is going to be attracted in on a significant basis when we’re really overly dependent on these extremely low rates and holding onto, in the Fed’s balance sheet, significant portions of these MBS.”
He also shares the concern that the housing market is on the verge of another bubble because of the low interest-rate environment. “What part of a bubble don’t people understand, where they’re looking at returns to 2007, 2008 housing prices as a sign of recovery?” the professor said
Even with tapering QEIII is a large intervention is important credit markets and is still an ineffective (relative to its stated goals) and long term harmful mondustrial policy.
After being relatively stable from September 2013 through December 2013, both the monetary base and bank excess reserves restarted their upward trend in January. Fed while slowing purchases on long end must be very active on short end again to maintain near zero interest.
Frank Hollenbeck writes in today’s Mises Daily:
The Economist magazine publishes twice yearly the Big Mac Index (video) which measures the “over- or undervaluation of a currency. Of course, the price of a hamburger has more to do with the cost of labor and rent than with the cost of the bun, meat, or pickles in a Big Mac. It is also a non-traded good, so we should not expect arbitrage to force uniformity in prices across countries or regions. The Economist is trying to sell magazines, so it is justified in being less than precise. However, professional economists should not be using this index, or any index, to identify a currency as undervalued or overvalued. In reality, such statements are total nonsense.
The value of a currency, as reflected in the exchange rate, is determined by supply and demand. The price of rice is not overvalued nor is the price of apples undervalued. Such a statement would be considered idiotic for rice or apples, but is considered justified for exchange rates. Equilibrium exists where the quantity demanded is equal to the quantity supplied. No one is overpaying or underpaying. To suggest that someone is indeed “overpaying” implies the buyer is irrational.
President Obama has named three more nominees to the Fed and the Senate has had a chance to interview them. The first and most important is Stanley Fischer, aged 70, nominee for vice chairman as well as a regular member.
The most curious thing about Fischer’s resume is that, having been born in Zambia, and naturalized as an American in 1976, he accepted Israeli citizenship in 2005 in order to become head of Israel’s central bank. Today he holds dual citizenship. Prior to living in Israel, he worked as a vice chairman of Citigroup from 2002-5, the years leading to the bank’s bail-out, and prior to that was deputy director of the International Monetary Fund, chief economist of the World Bank, and professor at MIT, where he taught Ben Bernanke among others. Somewhere along the way, he acquired a personal fortune of between $14 and $56mm.
We are thus to understand that President Obama, having searched the entire length and breadth of our land, could find nobody better than a 70 year old with Wall St. and International Monetary Fund baggage who had most recently worked for a foreign government.
The second nominee after Fischer is Lael Brainard, who has recently worked at the Treasury as an undersecretary. Ms. Brainard told senators that the Fed should protect “the savings of retirees.” She did not bother to explain how refusing to allow interest to be paid on savings, or seeking to foster inflation higher than interest would do so.
The final nominee, Jerome Powell, would be a reappointment. Although not a Phd economist and nominally a Republican from the George H. W. Bush administration, he fits the Obama mold in other ways, notably by being from Wall Street, and by being willing to keep quiet and go along. His most daring moment came when he called the Fed’s money creation machine under Bernanke and now under Janet Yellen “innovative and unconventional” and added that “likely benefits may be accompanied by costs and risks.” He has been a reliable vote for Bernanke and likely will be for the Yellen/Fischer regime as well.
Senator Corker ( R-Tenn.) waxed enthusiastic about this group of three, saying “I’m impressed,” and leading bond manager Mohamed El-Erian describes them as a “dream team” together with Yellen.
This does indeed seem to be a “dream team” for Wall Street, for corporations boosting profits to record levels with the help of government deficits, for other special interests feeding off the stimulus trough, and for government employees. For everyone else, it just promises more and eventually even worse economic misery.
A new NBER paper documents a strong, secular increase in US corporate borrowing during the Keynesian era.
Unregulated U.S. corporations dramatically increased their debt usage over the past century. Aggregate leverage – low and stable before 1945 – more than tripled between 1945 and 1970 from 11% to 35%, eventually reaching 47% by the early 1990s. The median firm in 1946 had no debt, but by 1970 had a leverage ratio of 31%. This increase occurred in all unregulated industries and affected firms of all sizes.
Not surprisingly, this change reflects government policy:
Changing firm characteristics are unable to account for this increase. Rather, changes in government borrowing, macroeconomic uncertainty, and financial sector development play a more prominent role.
Further evidence for the long-term lengthening of the economy’s capital structure, not from technological improvement, but from the government’s policy of always keeping interest rates below their market levels.
Chris Casey writes in today’s Mises Daily:
Regardless as to whether or not increased wealth will actually spur increased consumer spending, the most important component of the wealth effect is the assumption that increased consumer spending stimulates economic growth. It is this Keynesian concept which is critical to the wealth effect’s validity. If increased consumer spending fails to stimulate the economy, the theory of the wealth effect fails. Wealth effect turns into wealth defect.
Will increased consumer spending improve the economy? On one side of the argument, we have the aggregate individual conclusions of hundreds of millions of economic actors, each acting in their own best interest. These individuals and businesses are attempting to reduce consumer spending and increase savings.
Dissenting from their views are the seven members of the Board of Governors of the Federal Reserve. Each member believes in the paradox of thrift — the belief that increased savings, while beneficial for any particular economic actor, have deleterious effects for the economy as a whole.
Joseph Salerno writes in today’s Mises Daily:
Brown explains that such monetary disequilibrium is not necessarily manifested in consumer price inflation in the short run. In fact, it is generally the case that the symptoms first appear as rising temperatures on assets markets. Indeed some episodes of severe monetary disequilibrium, such as those that occurred in the U.S. during the 1920s, the 1990s, and the years leading up to the financial crisis of 2007-2008, may well transpire without any discernible perturbations in goods and services markets. Yet overheated asset markets are completely ignored in the Friedmanite view of monetary equilibrium that underlies the Bernanke-Draghi policy of inflation targeting. Brown perceptively argues that one reason for the wholesale neglect of asset price inflation is the positivist approach that is still dominant in academic economics. Speculative fever in asset markets is nearly impossible to quantify or measure and thus does not neatly fit into the kinds of hypotheses that are required for empirical testing.
Fox comedy Raising Hope explains Bernankism (from “Burt’s Bucks“, S04E02):
Needless to say, it doesn’t end well. The episode even features wheelbarrows of worthless money.
Also in this subgenre of money-creation-leads-to-hyper-inflation stories is this classic Duck Tales episode:
William Anderson Walter Block Per Bylund John Cochran Jeff Deist Thomas DiLorenzo Gary Galles David Gordon Jeffrey Herbener Robert Higgs Randall Holcombe David Howden Jörg Guido Hülsmann Peter Klein Hunter Lewis Matt McCaffrey Ryan McMaken Thorsten Polleit Joseph Salerno Timothy Terrell Mark Thornton Hunt Tooley Christopher Westley