Monday, September 26, 2016

Nomi Prins Interview on China, SDRs, and Gold

Recently Nomi Prins did this interview with King World News. Nomi is the author of All the President's Bankers and often appears in interviews on various mainstream and alterntive media sites. In addition she works with Jim Rickards on his Strategic Intelligence newsletter. You can listen to her full interview here.

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Topics Covered in this interview include:

- Her recent visit to China 

- Her visit to Brazil during the change of power there

- Comments on the inclusion of the Yuan into the SDR currency basket

- Comments on whether gold might be added to the SDR currency basket

- Her thoughts on where the gold market is headed short and medium term

- Her thoughts on when we may see a crisis unfold in the present monetary system

Wednesday, September 21, 2016

The "Gap" in Society - Are Some Trying to Reach Across it?

When you do research for articles on a blog like this, it forces you to read a lot articles and look at various internet forums. When you try to look at a broad variety of information coming from different points of view, it's hard to miss the fact that we really do have a big "gap" in our society today. 


Our present monetary system is run by what most people would view as the "elite" class. I hate labels and think it's better to deal with every person as an individual, but it's true that there is a widely held perception that regular citizens and the so called "elites" live in such different worlds that it is very hard for them to relate to each other. I do see clear evidence all the time that there is a gap that exists. This recent effort by the US Federal Reserve to connect with regular citizens by setting up a Facebook page is perfect example of what I mean. Zerohedge covers that with this somewhat amusing story of  how many regular citizens jumped at the chance to let the Fed know how they feel about their policies (or even their existence). The rise of Donald Trump and Bernie Sanders in the US clearly shows that millions are unhappy with the status quo, but still strongly disagree on how to change it.


Something that has been interesting to me though as I have worked on this blog is that I find there are actually some who many would view as "elites" that have the same concerns as many regular citizens do about how things are going in our monetary system. More and more are speaking out about concerns they have. Below are a few examples we have found along the way working on articles for this blog. After that, a few added comments.

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Earlier this year we ran an article about former BIS economist William White expressing his concerns about the current system. Here are a couple of excerpts from that article which was a Q&A type interview with William White:

Sean Corrigan: "As you say, I couldn’t agree more. It’s a question of dysfunctional banking and also of the debt hangover, which we haven’t addressed. And to me, QE is self-deceiving in that the liquidity issue, as you say, was the first rationale in the aftermath of the Lehman collapse was one thing, but to then try and use it as a macro tool when what you’re trying to do is make borrowing more attractive for people who have just been burnt by over borrowing seems"

William White: "Mad. It’s mad here and it’s mad everywhereIt’s more of what got us into trouble in the first place."

In response to question about the sustainablity of the present system, William White said this in Part II of his interview article:

William White: Yes. Sadly, I don’t think anybody’s capable of telling you precisely how and when the whole thing will come unstuck. Nevertheless, you know that at some point, it has to. It’s like all of these complex systems. What we know from studying them over time is that they fall apart on a regular basis, and it’s impossible to say precisely where or what the trigger will be. That raises the obvious question of what investors can do to protect themselves.

Here he mentions Robert Pringle:

William White: "Absolutely. It is notable that in the course of the last couple of years, the BIS in its Annual Reports has repeatedly used the phrase the ‘debt trap’. Very low interest rates encourage so much debt increase that central banks fear raising them again because you will bankrupt everybody. That is the debt trap. Similarly, Robert Pringle wrote a book in 2012 called “The Money Trap”, which is about the international side of this over extension.

Speaking of Robert Pringle, at the time I wrote the article above I had not ever had any contact with him. Later this year that changed as a reader here pointed me to his blog The Money Trap where he talks directly about the issues we cover here. In time, not only did I have the opportunity to make contact by email, he even provided me this powerful quote to use in a recent blog article here:

"Current monetary policies are immoral because….

….they weaken the institution of money, the crucial coordinating mechanism of each and every society. Following the inequitable allocation of  losses from the great financial crisis,  policy-makers are also knowingly further widening inequalities and divisions in society. The monetary mandarins treat people as tools to the realisation of ends that they, not the people, have chosen. They also view people as so stupid they will not understand what is going on." ---- Robert Pringle

This is not the first time Robert Pringle has spoken out against both policies and a system he feels has not been fair to the average person. I ran across this article detailing his comments to Parliament in the UK where he is sharply critical of how some banks have mistreated customers. Here is just one example quote from his comments to Parliament:

"4. What caused any problems in banking standards identified in question 1?

The problems in UK banking standards should be viewed broadly in the context of the evolution of UK monetary and economic policies in a globalised world economy. In particular, UK monetary policy has become caught up in a business cycle where, every few years, pressure mounts on the central bank to pursue excessively expansionary policies. These surges of officially-supplied liquidity leave “money on the table”—to use bankers’ language, ie easy pickings for the private sector, and a perennial source of temptation to lenders and borrowers to build up excessive leverage. Thus, in my judgment, the main underlying causes of these problems have been the weakness of regulatory policy (reflecting the fact that finance is globally integrated, while policy remains essentially national), and the permissiveness of monetary policy.
However, this does not excuse the boards, shareholders and management of financial institutions from the failures of judgment that occurred in institutions under their watch. One big problem was their narrow pursuit of maximising shareholder value—a pursuit that came close to destroying many companies."
Mr. Pringle offers a number of suggestions on how to deal with the way some banks abused the system. Here are just some of his comments:

7. What other matters should the Commission take into account? HMG should…

- Extend areas of financial offences where criminal prosecutions could be brought.
- Step up prosecutions for insider trading with custodial sentences.
- Ensure that “heads roll” when a bank misbehaves or asks for public assistance; the widely-held and powerful City myth is that when a bank goes to the Bank of England for emergency lending, the Governor responds by saying “Thank you, Mr Chairman, we shall discuss that with your successor; goodbye”. That is the kind of action that the City understands and was sorely missed in the crisis—for example, when RBS failed (I doubt if many people took any notice of the results of the FSA’s laborious inquiry—a 352-page report released three years later).
- Give the appropriate authorities discretion to take such action when appropriate even if they cannot prove the individual(s) was/were personally responsible.
- Make their expressed determination to end “too big to fail” credible in the markets, as the single most important step in restoring professional standards—and above all, the needed culture of risk-consciousness—at all levels of an institution.
- Encourage the Financial Conduct Authority to have as its central focus an insistence that financial institutions put the interests of clients/customers/consumers first at all times.
I point this out because here Mr. Pringle sounds much more like the "regular citizens" I see making comments about the unfairness of the system and that send me emails to express their frustrations. These are people who would likely be surprised to find out that someone highly respected in the Central Banking community would openly criticize the policies of central banks and also some big banks that feed off the central bank centered system we have now.
There are a number of others we could mention like former Dallas Fed President Richard Fisher and former Dallas Fed staffer Danielle Dimartino Boothformer BoE Governor Mervyn King etc.
Dr. Harald Malmgren (former economic adviser to US Presidents) has been active on twitter talking about all this as well. Here are some links to his recent twitter comments:
Former Central Bankers "lament where monetary policy is going" 

And then we have this recent interview with Dr. Warren Coats who agreed to answer some direct questions I see all the time from people who are skeptical of central banks.
There are certainly many more examples, but these will suffice to illustrate the point.
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My added comments: For the most part I try to minimize my own opinions here. Really, they are not what matters for most people. What does matter is what actually happens as the world deals with the problems in our present system and various solutions are put forward to try and fix things. 
Here's the thing though. In this case I will offer this observation formed after many years now of following these issues and looking at a variety of opinions on how to deal with the problems. At the end of the day, we are all in this together. 
I do understand that a very real gap does exist between many of those who run the system and many of those who must live in the system without much say in how it is run. So, when I see prominent and respected people like the ones listed above speaking out openly and honestly about the problems we see in the present system, I have deep respect for them. When I see regular citizens express their frustrations and point out very legitimate abuses by some who are in positions of great privilege in the present system, I deeply respect them as well. I think both deserve to be heard and are very sincere in their opinions.
There is no doubt we are a deeply divided society on many fronts. So, when some do make the effort to try and reach across the gap (on either side), I applaud them. I am convinced that if good solutions are not found to establish a monetary system that is both sustainable long term and places the proper priority on a stable value for whatever we use as money, we will all lose eventually. 
To that end, this blog is dedicated to doing anything it can to encourage people to reach across the gap and at least listen to another point of view. We may not agree, but we can listen and maybe find areas of acceptable compromise. If not, then we should expect that the odds we all lose are going to go up and we need to have a plan in mind to deal with that as individuals and families. I have no idea what path will eventually be taken and can only hope wise decisions will be made.
We will continue here to try and feature credible views from a variety of sources without pushing an agenda. I believe readers are capable of forming their own opinions very well without my input if presented with accurate information and a variety of credible views from across the marketplace of ideas.
This will continue to be the goal here in an effort to encourage people to reach across the gap now and then as we watch to see what really does happen with all this over time. I am encouraged that there are good people on both sides of the gap, so hopefully they can find ways to work together.
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Added notes: Robert Pringle (former Group of 30) had these comments upon reviewing a preview of this blog article:

"I was amused to to see my book footnoted in a publication by my old firm, the G30, "Fundamentals of Central Banking", where they laconically comment that "An obvious issue, but one too fundamental to treat here, is whether we need to revisit the issue of the International Monetary System, or nonsystem, as some see it." (page 52), along with Paul Volcker and Bill White - distinguished company indeed!

"Too fundamental"?   The G30 has always steered away from discussing the International Monetary System in any deep or critical way, even though it is surely at the core of what they were set up to do!" --- Robert Pringle

I will add this comment. Many people feel that people like Warren Coats and Robert Pringle are not accessible or interested in their concerns. I have found just the opposite to be true. Both are very open and interested in a respectful discussion of our monetary system problems and ideas on how to fix things. In that regard, if you have constructive and thoughtful comments on their ideas they are happy to hear them. They appreciate anyone who takes the time and effort to study these issues and consider their proposals.

You can email me at lonestarwhitehouse@gmail.com with any such comments or questions and I will pass them on. I would just request that you read their actual proposals in their own words first so that you can offer comments or ideas that are relevant to what they are actually proposing. Robert Pringle is particularly interested in ideas on how to get policy makers to think about these monetary system problems and take them seriously. You can find their work here:

Dr. Warren Coats Selected Works 

Robert Pringle - The Money Trap Blog                

Tuesday, September 20, 2016

A Gold Related Item as the Fed Meets (Gold vs. US Dollar vs. Bitcoin)

With the Fed meeting this week here is an item I ran across recently related to gold. It is a graphic (see below) that compares Gold vs. the US dollar vs. Bitcoin in terms of "The Top Ten Traits of Popular Investments". Readers can review the comparison chart to see if they agree or disagree with it on the ten points of comparison. Below the graphic are some added comments.

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caption

Ahead of the Fed meeting starting y, Rosland Capital has a graphic with 10 traits to consider for each of the three parts it compares. The visual originated from information on this page about IRAs backed by precious metals, but it also contains the Dollar and Bitcoin in addition to gold. (note: I have no affiliation with Rosland Capital and they are not a sponsor of this blog. They did provide this graphic and are interested in any reader feedback or comments on the information presented in the chart)
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My added comments: Readers here know that we do not expect that Bitcoin is likely to reach a broad base of users for the reasons listed in the article we published here last year. In regards to gold, we have stated many times here that readers should give consideration to how they might deal with another major financial crisis if we get one in the future. This might include creating an emergency fund that could include precious metals (gold and/or silver) for those who are able to consider that option. Some kind of plan is better than no plan just as having home owners insurance is better than not having it. It's a personal decision that will differ for each set of individual circumstances.


Reader comments on this chart are welcome below and also by email:

lonestarwhitehouse@gmail.com



Added note: In another gold related article, the OMFIF issues a press release about their new report called The Seven Ages of Gold:

"Central banks are turning back to gold purchases in line with a century of practice between 1870 and 1970. This has restored the yellow metal as a central element of monetary management after four decades of attempted demonetisation, according to a new report from OMFIF."

Sunday, September 18, 2016

Followup: Dr. Warren Coats offers some ideas on how to restore public trust

In this earlier article, Dr. Warren Coats answered some direct questions I asked related to the loss of public trust in public officials and the banking system we see today. In his answers, he provided a link to an article he wrote in April 2015 in which he offered some ideas on how to restore public trust in the monetary and banking systems.


As a followup to our earlier article, below are some excerpts from his April 2015 article in Cayman Financial Review. (bold underline for emphasis is mine)




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"The growth in the financial services industry has dramatically outstripped the services it actually performs: payments and allocating saving to investment. While experiences have varied around the world, the dramatic growth in bank risk-taking, especially in the U.S., has its origins in President Nixon’s termination in the early 1970s of the global monetary system – the Bretton Woods system – that anchored most currencies to gold and thus to each other, and dysfunctional and distorting tax systems that favor debt over equity.
Regulatory efforts to limit such risk-taking and thus avoid the severe damage to the world economy experienced from the Great Recession of 2008-09 have proliferated the costs of providing financial services and are likely to fail in their objective.
The growth of regulations along with the growth of the size and economic role of governments more generally are propelling the United States and others into the clutches of crony capitalism. Below I will offer some radical suggestions for changing directions.
Floating fiat currencies. The abandonment of the gold standard not only removed an important pillar of stability in international trade and payments, but also freed individual governments, and especially the U.S. government, from the restraining discipline of sound money on deficit financed spending. Financial markets responded to the new world of floating exchange rates by developing instruments to hedge the new exchange rate and interest rate risks."
. . . . . . 
"Efforts to counter recessions with monetary policy, something made possible by the abandonment of the gold standard or any other hard anchor to money’s value, have produced serious distortions in the U.S. and other economies as the result of prolonged periods of abnormally low interest rates. In the U.S. the dot.com and the subsequent real estate bubbles combined with the Greenspan put, then the Bernanke put, have encouraged highly leveraged financial risk-taking unimaginable even in the roaring 20s."
. . . . .
The American government’s expansion into many other areas of the economy, including the financial sector, has extended the government’s capture by industry to areas not imagined by Eisenhower.
"It is difficult for the government to objectively serve the public interest while dealing with and regulating industry. The relationship that develops in such a situation often serves the interests of the regulated industry more than the general public. The larger government becomes and the more involved it becomes in the economy, the larger the risks of regulatory capture. The resulting crony capitalism is the enemy of true capitalism as much as its variants socialism and fascism."
. . . . . 
Radical reforms
"We need a shift in the balance between market and government regulation of financial services toward more market regulation. To achieve this we need a change in the legal and policy foundations on which these markets operate.
Tax system: The least radical but still politically challenging reform of the tax system “would be to abolish corporation tax and to attribute all corporate income to shareholders.” (Martin Wolf, page 336) A more radical tax reform would be the elimination of all income taxes, personal and corporate, in favor of a value added tax as I have proposed in an earlier issue. 
In addition to being simple and economically efficient, it would make special interest carve outs much more difficult.
Monetary system: A critical reform is to return to the monetary discipline of a hard anchor to the money supply. The gold standard was such a system but had weaknesses that could be overcome with a broader and more stable anchor (a small valuation basket of goods). The logical starting place is to reform the International Monetary Fund’s reserve asset, the Special Drawing Right (SDR).
The IMF should replace the SDR’s valuation basket of key currencies with a basket of goods and replace the allocation of SDRs with their issue according to currency board rules (see note below). In addition to replacing the U.S. dollar as the international reserve currency this Real SDR would become an ideal anchor to which to peg national currencies, thus restoring a global currency that contributed so much to the expansion of world trade during the classical gold standard era. 
Banking system: Modest reforms of the banking system that may be underway are to significantly increase bank capital requirements and to rigorously adhere to a policy of imposing losses from insolvent banks on their owners, creditors and depositors (no bailouts). The combination of these two should greatly increase the safety of banks and the incentive for their investors and customers to monitor their risk-taking and thus to reduce the need for micromanaged supervision from regulators.
A more fundamental reform would be to separate the payment system from financial intermediation services by adopting the Chicago Plan of 100 percent reserves against monetary deposits at banks as proposed by Milton Friedman, Martin Wolf, Laurence Kotlikoff and others. If all monetary deposits were fully backed by deposits of the same amount with the central bank, no further regulations (beyond normal accounting and reporting requirements) would be needed for the payment subsidiaries of banks.
There would be no reason for bank runs and they would do no harm if they occurred. The lending and financial services subsidiary of a bank, or other financial institutions, would be funded with equity, as are equity mutual funds, as is required by Islamic banking, and would thus only require minimal regulation (fit and proper owners and transparency).
These admittedly radical reforms would provide a foundation for the development and operation of the financial sector that could rely very heavily on the regulation of its activities by its owners, investors, and customers with minimal government oversight."            . . . . .
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Added notes: For some people, a currency board may be a new concept they are not familiar with. I asked Dr. Coats for some help in explaining a currency board as he envisions it and he gave me this reply by email:

"See my book on One Currency for Bosnia. Your link is basically correct (here is the link I sent him) for existing currency boards. My Real SDR currency board would not be backed with the actual goods in the valuation basket, but with government securities of comparable value as a result of critically important "indirect" redeemability. The currency board rule means that the currency issuer is totally passive responding at the price fixed of the valuation basket to supply or redeem its currency in response to public demand for assets of equivalent current market value."

A key point is that "the currency issuer is totally passive" meaning they are not allowed to create currency based on their own desires or as this link explains -- "there can be no fiduciary issuing of money." Also, under a currency board "the central bank will no longer act as a lender-of-last-resort  and monetary policy will be strictly limited to that allowed by the banking rules of the currency board arrangement." For more on the concept of "indirect redeemability", go here.

Robert Pringle (former Group of 30) offered these relevant comments by email which I am including here for readers benefit (underline for emphasis is mine):

"The Ikon would work in the same way as Warren's Real SDR except it would not need indirect convertibility. A critical issue all our proposals have to confront was expressed by Martin Wolf in the FT last week (Sept 14).  To rebut calls for a hard anchor, or people who say central banks must follow a mechanical rule, such as the gold standard, MW writes:

"The lesson of history seems absolutely clear: a democracy will not accept that money is outside purposeful control. For now and the foreseeable future, we will remain in a world of monetary policy".

We believe on the contrary that central banks have given discretionary policy, inflation targeting with floating rates, etc their best shot and that it has failed. Confusing monetary and price signals caused by activist monetary policies are undermining the prosperity and stability on which confidence in democracy depends

The challenge is to persuade economists/policy makers of this.  With a few exceptions central bankers are a lost cause; the financial sector does well out of the current volatility so there is no powerful constituency for reform."  --- Robert Pringle

In addition, Mr. Pringle has two recent blog articles that expand on these issues:


Thursday, September 15, 2016

Can the General Public Trust Central Banks? Dr. Warren Coats Weighs In

This year we have featured the the proposal by Dr. Warren Coats to replace the US dollar with the SDR as the global reserve currency. This is because some (like Jim Rickards) have predicted that in the next big global financial crisis, the SDR will be put forward as a replacement for the US dollar in some way. 


Dr. Coats has long had a real proposal to do this that could actually be considered by the IMF which to me makes it more significant than people who speculate on how this might work from outside the system. Dr. Coats has just circulated a draft of a new paper that summarizes his Currency Board proposal and provided me a copy to review and offer comments on. The draft is currently on a Word document so I pasted in the full article at the end of this blog article below so that you can read it in full. The paper also gives a historical background as to why he has made this proposal.


Dr. Coats has been very kind to answer various questions I have raised to him about his Currency Board proposal in the past. Recently, I asked him if he would be willing to answer some more direct questions I get from readers (and also see from people who comment on this on various forums on the internet). 


The questions I asked this time were along the lines of why should the general public trust that central banks would follow the rules in his Currency Board proposal that would restrict their ability to create currency and also anchor it to a basket of goods (rather than leave it as a floating exchange rate against a basket of currencies as the SDR is now). Dr. Coats gave his answers to these questions and also permission to publish them here. Below are the questions and answers exactly as they appear in our email exchange on this.

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Q: If we agree that over the past years the policies that have been used by central banks have sometimes resulted in poor results, misallocation of capital, asset bubbles, etc. despite the best efforts of good people (due to the limitations of human beings), why should we trust these same people to fix the current problems?

A: We should not leave it to the central bankers themselves to propose giving up floating exchange rates for hard anchors (though most in fact have pushed for and gotten fixed exchange rates). This should be imposed on them by law. In the US case, congress should impose currency board rules with a unit of account of representative goods.  -- WC

Q: If central banks and politicians have demonstrated for many years now that they will ignore rules whenever it suits their interests and cave in to political pressure to spend money and then (if necessary) create new money out of thin air to keep the system from imploding as best they can, why should we believe they will change their behavior and follow a rules based Currency Board and a real world anchor for the currency?

A: Central banks do not (or rarely) ignore the law (rules) governing their behavior. Historically, it was the government seeking easy finance that push/forced their central banks to print money for them. The move of the last 40 years for independent central banks has largely solved that problem. But try as they might, even independent central banks find it difficult to achieve inflation targets most of the time. Ridged rules such as a fixed rate of growth of some monetary aggregate have not worked well and require discretion to make adjustments. 

Current congressional proposals (a draft law now in congress) would require the Fed to chose its own rule, such as a Taylor rule, as the default and if it believes circumstances call for a change, it would have to explain to congress why it thought so and did so.  This is about as good a realistic rule as you can get with floating exchange rates.  All currency boards (I exclude Argentina from the list as they were not a full fledged currency board) have followed currency board rules faithfully and with good result. The Bretton Woods, gold exchange standard system was too flexible and allowed central banks to drift too far from its requirements ultimately forcing adjustments in exchange rates. With good (realistic) rules imposed by law, I have full confidence the Fed will follow them with good results.  -- WC

Me: The only comment I can offer related to all this (the proposal to implement a Currency Board) is that I sincerely believe the #1 priority of policy makers at this point should be to try and restore the faith and confidence of the public in public officials. I think this has really been damaged as the average person gets up and goes to work every day trying to do the best they can to follow the rules and make an honest living. Then, they see that some are allowed to break or bend rules (sometimes greatly enriching themselves in the process) to such an extent that they put the entire financial system at risk and yet never seem to suffer any consequences for their behavior. I cannot tell you how many emails I have gotten over the years doing this blog from people disillusioned by what they perceive is a "rigged system" that favors some over others simply because they happen to work for a "too big to fail" entity. They feel like no one bailed out their company and people lost their jobs simply because the company where they worked was not important enough to impact the overall financial system. 

Dr. Coats: Most of the complaints from the public of a "rigged system" pertain to banking and financial sector supervision rather than monetary policy. They are related but very different issues. See my article on financial supervision: "Changing direction on bank regulation" Cayman Financial Review, April 2014 -- http://www.caymanfinancialreview.com/2015/04/22/Changing-direction-on-bank-regulation/

End of Q & A Section

Note: In the link provided by Dr. Coats above, he provides his ideas on how to restore public trust and confidence in both the monetary system and the banking system. See this followup article for more.

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Below is the full draft of Dr. Coats new paper which gives some historical background leading up to his proposal for a Currency Board and a hard anchor for a new global reserve currency. If readers have any comments they would like to offer just email me or post them below and I will pass them on. (email: lonestarwhitehouse@gmail.com)

Here is the concluding paragraph of the paper below to give you an idea of how Dr. Coats thinks about where central banks should be headed:

"Central banks need to return to monetary regimes with hard anchors in which money is issued in response to public demand under currency board rules.  Removing any uncertainty about the value of money would facilitate market adjustments to changing environments and shocks, and would force governments to manage their fiscal policies without recourse to manipulation of monetary policy.  While countercyclical monetary policy targeting inflation or NGDP might potentially reduce the amplitude of swings in employment and output, it is not obvious that it would produce faster long-term growth and, if history is any guide, it is highly unlikely that it would hit its intended target."  -- WC

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What is wrong with our monetary policy?
By Warren Coats (draft version)

“The Fed should be using its economic expertise to highlight the long-term devastating impacts of failing to provide the opportunity for the skills needed for the economy of the future,” Sen. Jeff Merkley of Oregon said this summer.[1]  

While it is a bit of a challenge to tease out what Senator Merkley really wants the Fed to do, his statement does epitomize the propensity of politicians to assign objectives to the Fed that it doesn’t have the power to achieve while neglecting those measures for which they themselves are responsible.  So what can and should the Fed do?

Until President Richard Nixon closed the gold window on August 15, 1971, and in 1973 permanently ended the United States’ commitment to exchange its currency held by other central banks for gold at the fixed price of $35 per ounce, U.S. monetary policy had been guided by and constrained by its commitments under the gold exchange standard adopted in the Bretton Woods agreements of 1945.  The gathering at Bretton Woods New Hampshire in July 1944 led to the creation the International Monetary Fund, the World Bank, and what is now the World Trade Organization.  The irresponsible Guns AND Butter spending of the Johnson administration on the war in Viet Nam and the war on poverty had undermined the fiscal discipline required by the gold exchange standard.  Since its abandonment, the Federal Reserve and other central banks have searched for and experimented with a variety of alternative approaches to monetary policy with floating exchange rates.

From the end of the Korean War through 1965 inflation measured by the consumer price index averaged around 2% per annum but rose the second half of the 1960s to 6% by the end of the decade. [2]  Along with closing the gold window, Nixon launched  a 90 day wage and price freeze on August 15, 1971, which turned into an almost three year period of wage and price controls. When they were finally lifted the CPI increased a staggering 12% in 1974.  Over this period the Fed implemented monetary policy via adjustments in the overnight interbank lending rate (the Fed funds rate) in light of, among other things, its objectives for the growth of monetary aggregates.  However, during this period the monetary aggregates played more the role of indicators of policy than of targets.

By the 1970s the Fed and the economics profession more generally had accepted fact that monetary policy influences economic activity and employment only temporarily, i.e. that in the long run there is no trade off between employment and inflation (a vertical long run Philips Curve).  Nonetheless, during this period the Fed remained more sensitive to increases in unemployment than inflation and tended to ease monetary policy more quickly when employment was threatened than it tightened it in the face of increases in inflation.  As the effects of changes in monetary policy take one to two years to show up in employment and inflation (Friedman’s “long and variable lags” in the effects of monetary policy), policy decisions need to be based on forecasts of their future impact.  Thus the Fed’s bias toward fighting unemployment was compounded because during this period the Fed’s economic forecasting models persistently underestimated NAIRU—the Non-Accelerating Inflation Rate of Unemployment, also called the natural rate of unemployment—leading the Fed to maintain “easy money” conditions for too long.

The net result of these factors was that with ever higher inflation peaks the market’s expectations of future inflation began to increase.  Expected inflation was increasingly built into wage agreements.  During this period higher inflation was empirically associated with higher unemployment (a positively sloped Philips Curve).  Growing public and Congressional concern with inflation and broader professional acceptance of the “Monetarist” views of Milton Friedman resulted in 1977 in amendments to the Federal Reserve Act to clarify the Fed’s mandate as the pursuit of stable prices, maximum employment, and moderate long-term interest rates. 

To further tighten congressional guidance of monetary policy and to remove its inflationary bias Congress enacted the Full Employment and Balanced Growth Act of 1978, commonly called the Humphrey-Hawkins act, which required, among many other provisions, that the Fed establish targets for the growth of monetary aggregates and to report them and progress in achieving them to Congress twice yearly.  Given the widely accepted fact that monetary policy has no long run effect on employment, determining maximum employment consistent with stable prices (NAIRU) was an important challenge for fulfilling the Fed’s congressional mandates.

In the face of the Fed’s persistent over shooting of its narrow and broad money target ranges and the entrenching of higher and higher inflation expectations in wage and price increases, Federal Reserve Board Chairman Paul Volcker led the Board and the Federal Open Market Committee (FOMC) on October 6, 1979 in a dramatic change in the Fed’s approach to implementing monetary policy by shifting to an intermediate, narrow money target, operationally implemented via a target for non-borrowed reserves.  The new approach required the Fed to relax its Fed funds rate targets and it increased the band set by the FOMC for the Fed funds rate from 0.5% to 4%.  The most important element of this dramatic shift was the acceptance by the Fed of its responsibility for inflation and elevating its objective of price stability to first place.

Volcker explained the Board’s thinking in his first Humphrey-Hawkins testimony on February 19, 1980:

In the past, at critical junctures for economic stabilization policy, we have usually been more preoccupied with the possibility of near-term weakness in economic activity or other objectives than with the implications of our actions for future inflation.  To some degree, that has been true even during the long period of expansion since 1975.  As a consequence, fiscal and monetary policies alike too often have been prematurely or excessively stimulative, or insufficiently restrictive.  The result has been our now chronic inflationary problem, with a growing conviction on the part of many that this process is likely to continue. . . .
The broad objective of policy must be to break that ominous pattern.  That is why dealing with inflation has properly been elevated to a position of high national priority. Success will require that policy be consistently and persistently oriented to that end.  Vacillation and procrastination, out of fears of recession or otherwise, would run grave risks.  Amid the present uncertainties, stimulative policies could well be misdirected in the short run; more importantly, far from assuring more growth over time, by aggravating the inflationary process and psychology they would threaten more instability and unemployment.

The new approach was not easy to implement.  The Fed not only had to refine its new operating procedures to better control monetary aggregates but also had to enforce new Humphrey-Hawkins requirements such as reducing monetary growth targets over time and the gradual reduction of the inflation rate to zero by 1988.  Further complicating its policy implementation, on March 14, 1980 it gave in to the Carter administration’s pressure to establish credit controls on banks.  But as a result of the unsurprising, poor results of such controls it dismantled them completely less than four months later on July 3.  The biggest challenge to the new procedures, however, came from shifts in the demand for money that were to some extent precipitated by the new focus on monetary targets and the liberalization of deposit interest rates, the expanding use of credit cards, and the emergence of competing near moneys.

A detailed inside review by David Lindsey of Fed policy formulation from 1975 to 2002 states that: “The Federal Reserve discovered that pragmatic money targeting could not be done on a computer, as Milton Friedman had advocated.  Communicating the ins and outs of monetary targeting in practice similarly was not easy….

“Experience with the extreme volatility of desired holdings of transactions balances was fresh for the FOMC going into its July 9 [1980] meeting.  Small wonder that the Committee's initial decision was as laid out in its Humphrey-Hawkins report to the Congress:

“While there is broad agreement in the Committee that it is appropriate to plan for some further progress in 1981 toward reduction of the targeted ranges, most members believe it would be premature at this time to set forth precise ranges for each monetary aggregate for next year, given the uncertainty of the economic outlook and institutional changes affecting the relationships among the aggregates.”[3]

On July 1, 1982, in the midst of the relatively sharp recession of 1981-2, the Fed raised its narrow money growth target and started lowering the funds rate.  Then, in October, it gave up its intermediate money targeting and dropped the non-borrowed reserves operating target.  The Fed’s abandonment of tight targets for monetary aggregates represented a failure, to some extent at least, in Congress’ intention to provide the Fed with clear policy rules. 

In response to Volcker’s July 1982 Humphrey-Hawkins report to an unhappy congress:

“The [House] Committee was concerned that changing the monetary target from the mid-point to the upper end of an unchanged range "seriously obscures" the Fed's intentions with regard to monetary policy.  ‘By changing its ostensible target without changing its target range, the Federal Reserve in its July 20 report seriously obscures its intentions on monetary policy and fails to act in consistency with the reporting requirements of the Humphrey­ Hawkins Act….  Under that law, the Federal Reserve is required to report ranges of growth of the monetary aggregates and not some obscure hybrid of ranges and targets-within-ranges.’  The Committee was concerned that the Fed's policy ‘could be viewed by market analysts as abandonment of any kind of target scheme.’

“The report continued ‘if changed conditions merit a change in the targets, then a change in the ranges should be reported.  If ranges are not changed, they should be hit.  The current policy of 'brinksmanship' in which the Federal Reserve announces that it is aiming for the ceiling of its ranges, is unsatisfactory.  The Federal Open Market Committee should, at its next meeting, correct its presentation of its targets and report either a change or no change in its announced aggregate-growth target ranges.’"[4]

Despite these difficulties—the fed funds rate rose temporarily to over 22% and GDP fell by over 2% in 1982—actual and expected inflation were reversed and fell below 2½% by 1983. 

Importantly, having licked inflation, the Fed continued to give primacy to its price stability mandate, though with a more flexible and traditional operational approach.  The era of the great moderation in the volatility of GDP and inflation followed but the search for suitable monetary policy operational rules continued.

The non-borrowed reserves operating target of October 1979 to October 1982 was replaced with a borrowed reserve target.  It was not without difficulties.  The straw that broke the camel’s back was reported by Lindsey:

Eating Humble Pie along with the Thanksgiving Turkey
November 22, 1989

Just before Thanksgiving 1989, the Manager was, as in previous months, trying to implement the procedures geared mainly to an operating target for adjustment plus seasonal borrowings.  He had been attempting to place primary emphasis on reserve needs in Desk operations and secondary importance on the funds rate quoted in the market at the time of Desk action.  On that Wednesday before Thanksgiving, the Desk needed to add reserves for technical reasons.  Even though the funds rate slipped from 1/16 percentage point to 1/8 percentage point below the Committee's funds rate expectation just before the operation, the Desk still arranged a five-day System repurchase agreement (RP). Market participants interpreted the operation as signaling a policy move, when it in fact did not.  On Friday morning, the New York Times cited ‘government officials’ claiming (albeit erroneously) that an easing had taken place.  The policy record of the December meeting that year mentioned the episode: ‘Conditions in reserve markets softened temporarily around Thanksgiving when operations to meet seasonal reserve needs were misread as signaling a further easing of monetary policy.’  After the incident, the Desk put top priority on signaling the Committee's intended funds rate.  And that's the story of how the FOMC lost its borrowing procedures.”[5]

At about the same time radical innovations in the development of monetary policy rules were launched by the Reserve Bank of New Zealand, which came to be known as explicit inflation targeting.[6]  An inflation target provides a clear and explicit rule that permits flexible operational approaches to its achievement.  Given Friedman’s long and variable lags in the effect of monetary policy, setting monetary operational targets (almost always the equivalent of a fed funds rate) must be based on the best model assisted forecast of its consistency with the inflation target one to two years in the future.  A longer target horizon provided more scope for smoothing the output gap (employment).  Full transparency of the policy and the data and reasoning underlying policy settings is required to gain the benefits of the alignment of market inflation expectations with the policy target.[7] 

The RBNZ’s development and adoption of inflation targeting was an important development in the pursuit of rule based monetary policy with floating exchange rates that accommodated flexible implementation.  It swept the world of central banking.[8]  While the Fed did not adopt explicit inflation targets until 2012, it clearly pursued an implicit inflation target long before that.

The FOMC made its inflation target explicit in January 2012:

“The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate….

“The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market.  These factors may change over time and may not be directly measurable.  Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision.”[9] 


The Great Recession of December 2007 to June 2009 highlighted the failure of inflation targeting to take account of asset price bubbles and for "inappropriate responses to supply shocks and terms-of trade shocks".[10]  What followed can only be described as a nightmare (largely because of weaknesses in the U.S. financial system).  After properly and successfully performing its function of a lender of last resort and thus preventing a liquidity-induced collapse of the banking system, the Fed went on to undertake ever more desperate measures to reflate the economy.  These Quantitative Easing (QE), quasi-fiscal activities have been widely discussed and have contributed little to economic recovery.[11] 

With the “failure” of inflation targeting, nominal GDP targeting is now gaining support.  With a NGDP target when real GDP slows or falls, the inflation target is automatically increased in countercyclical fashion.  The rationale for this approach reflects the view inspired by Keynesian aggregate demand management that government policy, whether fiscal or monetary, can assist the market’s own adjustments to shocks of one sort or another.  While measures of aggregate demand can be useful for analysis, actual government expenditure components of aggregate demand are specific to individual projects and unlikely to coincide with areas of actual excess capacity.  NGDP targeting also ignores the role and benefits of stable money (a constant, preferably zero, rate of inflation) for private market calculations and adjustments to changing real circumstances.  Investor must augment their assessments of real economic conditions and prospects with their guesses about monetary policy and its impact.

Each household’s, or region’s, or country’s balance of payments with the rest of the world is regulated by individual budget constraints—what the household is able to produce (its income) and is thus capable of buying (smoothed by what it is able to borrow and/or has previously saved).  Dynamic, growing economies are always adjusting to changing consumer tastes, new technologies, failed firms, changes in prices of internationally traded goods, etc.  These adjustments, which may entail painful periods of retraining and/or unemployment for workers, and capital reallocation for firms are a necessary aspect of growing economies.  The goal of all active stabilization policies, fiscal or monetary, is to reduce the pain of market adjustments to shocks by actively adding to deficient demand or diminishing excess demand, thus spreading the adjustment over a longer period.  The passive elements of fiscal policy—automatic stabilizers such as unemployment insurance—are generally accepted as helpful along with the rest of the social safety net.

The potential, temporary contribution of monetary policy to smoothing swings in output come from speeding up adjustment by pushing interest rates even lower than would market forces alone during downswings and higher than the market alone would produce when output is over heating.  This can be achieved by pushing money growth above the growth in its demand or visa versa (or equivalently by pushing interest rates below or raising them above their natural real rate).  Interest rates below the full employment rate (by more than the market would produce on its own) should encourage increased borrowing and investment, increases in asset prices (including real estate) that increase consumption, and depreciation of exchange rates that increase net exports and thus a quicker closing of the output gap.  

When interest rates are lowered to zero (the lower zero bound), consumption and investment cannot be stimulated further via the interest rate channel for transmitting monetary policy nor can they further depreciate the exchange rate.  Consumption can potentially be stimulated via the wealth effect of increasing asset prices but at the expense of distorting resource allocation (asset bubbles).  This leaves negative real interest rates (e.g. by increasing inflation) and helicopter money (increased government transfers, e.g. by the reduction of social security wage taxes, financed by printing money).

For these countercyclical policies to make a positive contribution to price and output stability, the central bank must be able to correctly forecast the interest rate or money supply required for the inflation or NGDP targets in one to two years in the future.  This requires, among other things, correctly determining the natural real rate of interest and sustainable real output, both of which are unobservable.  The conclusion from the above history is that monetary policy is being asked to deliver more than it is capable of delivering.  Central banks are generally staffed by very capable people, but they can never know all that they need to know to keep the economy at full employment as employers and jobs keep changing. The quality of forecasting models has greatly improved in recent years but they remain unreliable.  In addition, politicians like Senator Jeff Merkley expect the Fed to perform miracles that are beyond its capacity while Congress continues to spend and regulate destructively.  In my opinion, central banks have given their price stability mandates their best shot and failed.  The successful management of the money supply with floating exchange rates is simply beyond the capacity of mortals.

The alternative is to return to a hard anchor for monetary policy.  This means linking the value of money to something real and managing its supply consistent with that value (exchange rate).  Such regimes do not magically overcome a economy’s many and continuous resource allocation and coordination challenges, but by providing a stable unit in which to value goods and services and to evaluate investment options, and sufficient liquidity with which to transact, such regimes facilitate the continuous adjustments private actors need to make for an economy to remain fully employed and to grow.

But fixed exchange rate regimes, including the gold standard in one of its forms or another, have had their problems as well.  These problems generally reflected one or the other of two factors.  The first was the failure of the monetary authorities to play by the rules of a hard anchor, which is to keep the supply of money at the level demanded at money’s fixed value.  The pressure to depart from the rules of fixed exchange rates generally came from fiscal imbalances or mistaken Keynesian notions of aggregate demand management.  However, even when central banks aimed actively to match the supply of its currency to the market’s demand with stable prices it proved beyond their capacity to do so.

The second source of failure came from fixing the value of money to an inappropriate anchor.  When the exchange rate of a currency is fixed to another currency or commodity whose value changes in ways that are inappropriate for the economy, domestic price adjustments can become difficult and disruptive.  Fixing the exchange rate to a single commodity, as with the gold standard, transmitted changes in the relative price of gold to prices in general, which imposed considerable hardships on the public.  

Consider, for example, the previous era of globalization in the late nineteenth century.  World “wide demand for gold rose much more than the supply from the 1870s through the mid-1890s as nearly two dozen countries adopted or re-adopted the gold standard, and hence needed to accumulate reserves.  Two of the world’s largest economies, the United States and France, also made growing use of gold coins.  Indeed, demand drove the commodity-exchange value of gold to the highest level it was to reach in four centuries of record-keeping—the flip-side of deflation of other commodity prices.  The commodity price decline reduced profits and chilled investment demand.”[12]

These historical weaknesses of monetary regimes with hard anchors can be overcome by choosing better anchors and by replacing central bank management of the money supply with market management via currency board rules.  I have discussed these improvements extensively in earlier papers but summarize them briefly here. 

The value of the IMF’s SDR is determined by the market value of fixed amounts of (soon to be) five currencies.  Such an anchor is by its nature more stable than is the value of any one of the currencies in the SDR’s valuation basket (USD, Euro, Yen, GBP, and RMB).  Broadening a commodity anchor to include a number of diverse commodities would be an improvement over the use of a single commodity such as gold.  The most stable anchor relative to purchasing power would be the basket of goods in a representative consumer price index basket (CPI).  Such an anchor is proposed in my Real SDR Currency Board paper.[13][14]

The public will demand to hold an amount of money (currency plus transaction deposits at banks) in light of the value of its anchor that generally varies with income and the opportunity cost of holding money (interest rates).  In addition, however, advances in payment technology and innovations in financial instruments have affected and will continue to affect the demand for money.  These variations in money demand create serious challenges to central bank management of the supply of money that do not exist when issuing currency via currency board rules in response to market demand.  Under currency board rules the public can always buy and hold exactly the amount of money it wants at its official anchor price.

Central banks need to return to monetary regimes with hard anchors in which money is issued in response to public demand under currency board rules.  Removing any uncertainty about the value of money would facilitate market adjustments to changing environments and shocks, and would force governments to manage their fiscal policies without recourse to manipulation of monetary policy.  While countercyclical monetary policy targeting inflation or NGDP might potentially reduce the amplitude of swings in employment and output, it is not obvious that it would produce faster long-term growth and, if history is any guide, it is highly unlikely that it would hit its intended target. 

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Warren Coats retired from the International Monetary Fund in 2003 where he led technical assistance missions to the central banks of more than twenty countries (including Afghanistan, Bosnia, Egypt, Iraq, Kenya, Serbia, Turkey, and Zimbabwe).  He was Chief of the SDR Division of the Finance Department of the IMF from 1982-88 and a visiting economist at the Board of Governors of the Federal Reserve in 1979.  He has a BA in economics from U.C Berkeley and a PhD in economics from the University of Chicago.


[2] In addition to closing the Gold window and a 90-day wage and price freeze, the Nixon Shock also included a 10% surcharge on existing tariffs on imports.

[3] David E. Lindsey, A Modern History of FOMC Communication: 1975-2002 FOMC Secretariat, June 24, 2003 page 55.

[4] Lindsey, Ibid. page 60.
[5] Lindsey, Ibid.  page 93.

[6] Key roles in developing the forecasting models and decision making processes at the RBNZ and subsequently at the Bank of Canada and else where were played by Doug Laxton and David Rose at that time from the Bank of Canada.

[7] Geoffrey Heenan, Marcel Peter, and Scott Roger, 2006, “Implementing Inflation Targeting: Institutional Arrangements, Target Design, and Communication,” IMF Working Paper 06/278 (Washington: International Monetary Fund)

[8] As of March 2012, 28 central banks had formally adopted inflation targeting policy regimes.

[9] Minutes of the Federal Open Market Committee, January 24–25, 2012.

[10] Jeffrey Frankel. "The Death of Inflation Targeting". Project Syndicate, May 16, 2012.

[11] See for example, Warren Coats, “US Monetary Policy: QE3”, Cayman Financial Review January 2013.

[12] Clark Johnson, “Did Keynes Make His Case?” Journal of Economics Library Vol 3, Issue 2, June 2016.

[13] Warren Coats, "Real SDR Currency Board"Central Banking Journal XXII.2 (2011).

[14] The very important feature of indirect redeemability (issuing and redeeming SDRs for assets of equivalent value rather than the goods in the basket) is discussed in the above article as well.


References


Coats, Warren "The D E Fs of the Financial Markets Crisis" CATO Institute, September 26, 2008.

_______  "The Big Bailout--What Next?", CATO Institute, October 3, 2008.

_______  (Editor) Inflation Targeting in Transition Economies: The Case of the Czech Republic, (Prague: Czech National Bank and Washington DC: International Monetary Fund) 2000.

_______  with Douglas Laxton, and David Rose (Editors), The Czech National Bank's forecasting and policy analysis system, Czech National Bank (Prague), March 2003).

______ "Real SDR Currency Board", Central Banking Journal XXII.2 (2011), also available at http://works.bepress.com/warren_coats/25

______ “US Monetary Policy: QE3”, Cayman Financial Review January 2013. http://www.caymanfinancialreview.com/2013/01/11/US-monetary-policy--QE3/ 

______ "A modest proposal: Helicopter money and pension reform,"  Cayman Financial Review, May 2016

Heenan, Geoffrey, Marcel Peter, and Scott Roger, 2006, “Implementing Inflation Targeting: Institutional Arrangements, Target Design, and Communication,” IMF Working Paper 06/278 (Washington: International Monetary Fund)

Frankel, Jeffrey. "The Death of Inflation Targeting". Project Syndicate, May 16, 2012.

Johnson, Clark. “Did Keynes Make His Case?” Journal of Economics Library Vol 3, Issue 2, June 2016.

David E. Lindsey, A Modern History of FOMC Communication: 1975-2002 FOMC Secretariat, June 24, 2003.

______   A Century of Monetary Policy at the Fed, Palgrave Macmillan, 2016.

_______  with Athanasios Orphanides, and Robert H. Rasche, “The Reform of October 1979: How It Happened and Why” Federal Reserve Bank of St. Louis Review March/April, 2005.