The Federal Reserve and “Fiscal Dominance”

Appearing on Vance Ginn’s Let People Prosper, I discussed spending caps, entitlement reform, past fiscal victories, and potential future defeats.

For today, I want to highlight what I said about monetary policy.

The above segment is less than three minutes, and I tried to make two points.

First, as I’ve previously explained, the Federal Reserve goofed by dramatically expanding its balance sheet (i.e., buying Treasury bonds and thus creating new money) in 2020 and 2021. That’s what produced the big uptick in consumer prices last year.

And it’s now why the Fed is raising interest rates. Part of the boom-bust cycle that you get with bad monetary policy.

Second, I speculate on why we got bad monetary policy.

I’ve always assumed that the Fed goofs because it wants to stimulate the economy (based on Keynesian monetary theory).

But I’m increasingly open to the idea that the Fed may be engaging in bad monetary policy in order to prop up bad fiscal policy.

To be more specific, what if the central bank is buying government bonds because of concerns that there otherwise won’t be enough buyers (which is the main reason why there’s bad monetary policy in places such as Argentina and Venezuela).

In the academic literature, this is part of the discussion about “fiscal dominance.” As shown in this visual, fiscal dominance exists when central banks decide (or are forced) to create money to finance government spending.

The visual is from a report by Eric Leeper for the Mercatus Center. Here’s some of what he wrote.

…a critical implication of fiscal dominance: it is a threat to central bank success. In each example, the central bank was free to choose not to react to the fiscal disturbance—central banks are operationally independent of fiscal policy. But that choice comes at the cost of not pursuing a central bank legislated mandate: financial stability or inflation control. Central banks are not economically independent of fiscal policy, a fact that makes fiscal dominance a recurring threat to the mission of central banks and to macroeconomic outcomes. …why does fiscal dominance strike fear in the hearts of economists and financial markets? Perhaps it does so because we can all point to extreme examples where fiscal policy runs the show and monetary policy is subjugated to fiscal needs. Outcomes are not pleasant. Germany’s hyperinflation in the early 1920s may leap to mind first. …The point of creating independent central banks tasked with controlling inflation…was to take money creation out of the hands of elected officials who may be tempted to use it for political gain instead of social wellbeing.

A working paper from the St. Louis Federal Reserve Bank, authored by Fernando Martin, also discusses fiscal dominance.

In recent decades, central banks around the world have gained independence from fiscal and political institutions. The proposition is that a disciplined monetary policy can put an effective brake on the excesses of political expediency. This is frequently achieved by endowing central banks with clear and simple goals (e.g., an inflation mandate or target), as well as sufficient control over specific policy instruments… Despite these institutional advances, the resolve of central banks is chronically put to the test. … the possibility of fiscal dominance arises only when the fiscal authority sets the debt level.

The bottom line is that budget deficits don’t necessarily lead to inflation. But if a government is untrustworthy, then it will have trouble issuing debt to private investors.

And that’s when politicians will have incentives to use the central bank as a printing press.

P.S. Pay attention to Italy. The European Central Bank has been subsidizing its debt. That bad policy supposedly is coming to an end and things could get interesting.

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Understanding Keynesian Economics

While speaking last week at the Acton Institute in Michigan, I responded to a question about the perpetual motion machine of Keynesian economics.

For purposes of today’s column, let’s try to understand the Keynesian viewpoint.

First and foremost, they think spending drives the economy, whether consumer spending or government spending.

Critics like me argue that the focus should be on income and production. We want to increase saving, investment, entrepreneurship, and labor supply. Simply stated, money has to be earned before anyone spends it.

Keynesian economists, by contrast, think it is very important to distinguish between the long run and short run. In the long run, they generally would agree with the previous paragraph.

But they would argue that “stimulus” policies can be desirable in the short run if there is an economic downturn.

More specifically, they argue you can stop or minimize a recession with fiscal Keynesianism (politicians borrowing in order to boost spending) and/or monetary Keynesianism (the central bank creating money to boost spending).

I then point out that Keynesianism has a history of failure when looking at real-world evidence.

• It didn’t work for Hoover.
• It didn’t work for Roosevelt.
• It didn’t work for Japan.
• It didn’t work for Europe.
• It didn’t work for Obama.
• It didn’t work for Biden.

It’s also worth pointing out that Keynesians have been consistently wrong with predicting economic damage during periods of spending restraint.

• They were wrong about growth after World War II (and would have been wrong, if they were around at the time, about growth when Harding slashed spending in the early 1920s).
• They were wrong about Thatcher in the 1980s.
• They were wrong about Reagan in the 1980s.
• They were wrong about Canada in the 1990s.
• They were wrong after the sequester in 2013.
• They were wrong about unemployment benefits in 2020.

As you might expect, Keynesians would claim I’m misreading the evidence. They would argue that their policies prevented even-deeper recessions. Or that periods of spending restraint prevented the economy from growing faster.

So you can see why the debate never gets settled.

I’ll close with the observation that Keynesian policies actually can impact the economy. As I pointed out in the video, we can artificially boost overall consumption and spending in the short run if politicians finance a so-called stimulus by borrowing money from overseas. And we can lure people and businesses into borrowing and spending in the short run by having a central bank create more money.

But that’s sugar-high economics, the kind of approach that only helps vote-buying politicians.

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Bank Failures and the Federal Reserve’s Recipe for Hangover Economics

Want to know who to blame for the failure of Silicon Valley Bank, Signature Bank, and the general turmoil in the banking sector?

Poor management is part of the answer, of course, but the Federal Reserve also should be castigated because of bad monetary policy.

Why?

Because the central bank’s easy-money policy created artificially low interest rates, but those policies also produced high inflation, and now interest rates are going up as the Fed tries to undo its mistake.

Inspired by my “magic beans” visual, here’s a new one that shows the Fed’s boom-bust cycle.

By the way, the center box (higher prices) also includes asset bubble since bad monetary policy sometimes leads to financial bubbles instead of (or in addition to) higher consumer prices.

And higher interest rates can occur for two reasons. Most people focus on the Federal Reserve tightening monetary policy as it tries to reverse its original mistake of easy money. But don’t forget that interest rates also rise once lenders feel the pinch of inflation and insist on higher rates to compensate for the falling value of the dollar.

But let’s not digress too much. The focus of today’s column is that the Fed goofed by creating too much money in 2020 and 2021. That’s what set the stage for big price increases in 2022 and now economic instability in 2023.

Joakim Book of Reason shares my perspective. Here are excerpts from his article.

The Federal Reserve is in the unenviable position of achieving its mandate by crashing the economy. …it’s something that happens as an unavoidable outcome of slowing down an economy littered with excess money and inflation. …This hiking cycle, the fastest that the Fed has embarked upon in a generation, was always likely to break something. And break something they did over the weekend…Silicon Valley Bank (SVB), which faced the second-largest bank run in U.S. history. …this pushes the Fed into a very delicate position: risk systemic bank runs, or roll back the hikes and quantitative tightening that caused this mess, printing money for an even hotter inflation.

The Wall Street Journal also has the right perspective, editorializing that the current mess was largely caused by bad monetary policy.

Cracks in the financial system emerge whenever interest rates rise quickly after an easy-credit mania, and the surprise is that it took so long. …This week’s bank failures are another painful lesson in the costs of a credit mania fed by bad monetary policy. The reckoning always arrives when the Fed has to correct its mistakes. …We saw the first signs of panic in last year’s crypto crash and the liquidity squeeze at British pension funds. …nobody, least of all central bank oracles, should be surprised that there are now bodies washing up on shore as the tide goes out.

This tweet also notes that monetary policy is to blame.

What's the main monetary lesson from SVB?

Wrong: See what inflation-fighting does? It can cause a financial crisis. So give up and adjust the inflation target to 4%.

Right: Inflation must be fought ASAP. The longer the delay, the bigger the pain.
P.S. Don't print so much money! pic.twitter.com/2XgkpTXiO0

— Dror Goldberg (@DrorGoldberg) March 13, 2023

Finally, I can’t resist sharing some excerpts from Tyler Cowen’s Bloomberg column. He pointed out last November that the Austrian School has some insights with regards to the current mess.

The Austrian theory…works something like this: Investors expected that very low real interest rates would hold. They committed resources accordingly, and now forthcoming rates are likely to be much higher. That means the economy is stuck with malinvestment and will need to reconfigure in a painful manner. …The basic story here fits with the work of two economists from Austria, Ludwig Mises and Nobel laureate Friedrich von Hayek, and thus it is called the Austrian theory of the business cycle. The Austrian theory stresses how mistaken expectations about interest rates, brought on by changes in the rate of inflation, will lead to bad and abandoned investment projects. The Austrian theory has often been attacked by Keynesians, but in one form or another it continues to resurface in the economic data.

Needless to say, proponents of the Austrian School are not big fans of central banking.

If you want to learn more about Austrian economics, click here and here.

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Deficit Spending and Inflation

In this segment from a December interview, I explain that budget deficits are most likely to produce inflation in countries with untrustworthy governments.*

The simple message is that budget deficits are not necessarily inflationary. It depends how budget deficits are financed.

If a government finances its budget deficits by selling bonds to private savers and investors, there is no reason to expect inflation.**

But if a government finances its budget deficits by having its central bank create money, there is every reason to expect inflation.

So why would politicians ever choose the second option? For the simple reason that private savers and investors are reluctant to buy bonds from some governments.

And if those politicians can’t get more money by borrowing, and they also have trouble collecting more tax revenue, then printing money (figuratively speaking) is their only option (they could restrain government spending, but that’s the least-preferred option for most politicians).

Let’s look at two real-world examples.

• Consider the example of Japan. It has been running large deficits for decades, resulting in an enormous accumulation of debt. But Japan has very little inflation by world standards. Why? Because governments bonds are financed by private savers and investors, who are very confident that the Japanese government will not default..
• Consider the example of Argentina. It has been running large deficits for decades. But even though its overall debt level if much lower than Japan’s, Argentina suffers from high inflation. Why? Because the nation’s central bank winds up buying the bonds because private savers and investors are reluctant to lend money to the government.

If you want some visual evidence, I went to the International Monetary Fund’s World Economic Outlook database.

Here’s the data for 1998-2022 showing the average budget deficit and average inflation rate in both Japan and Argentina.

The bottom line is that prices are very stable in Japan because the central bank has not been financing Japan’s red ink by creating money.

In Argentina, by contrast, the central bank is routinely used by politicians as a back-door way of financing the government’s budget.

*To make sure that my libertarian credentials don’t get revoked, I should probably point out that all governments are untrustworthy. But some are worse than others, and rule-of-law rankings are probably a good proxy for which ones are partially untrustworthy versus entirely untrustworthy.

**Borrowing from the private sector is economically harmful because budget deficits “crowd out” private investment. Though keep in mind that all the ways of financing government (taxes, borrowing, and money creation) are bad for prosperity.

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Central Bankers Dodging Blame

The great Milton Friedman repeatedly explained that rising prices are an inevitable consequence of easy-money policies by central banks.

That’s a lesson everyone should have learned about 50 years ago when the Federal Reserve unleashed the inflation in the 1960s and 1970s (also blame Lyndon Johnson and Richard Nixon for appointing the wrong people).

And we should have learned another lesson when the Fed (with strong support from Ronald Reagan) then put the inflation genie back in the bottle in the 1980s.

But today’s central bankers must have been very bad students.

Writing for National Review, E.J. Antoni explains that we are once again bearing the inevitable cost of bad monetary policy.

…central banks are allowing interest rates to rise in an effort to belatedly respond to a crisis they helped cause. …the global economic downturn has been baked into the cake for months. …central banks around the world laid the groundwork for economic pain when they decided to finance trillions of dollars in unfunded government spending in 2020. As those central banks continued — and in some cases accelerated — their excessive money creation throughout 2021 and into 2022, a global downturn became inevitable. …History shows that high levels of inflation almost always lead to recession …once inflation became apparent central bankers persisted with their earlier course, feeding inflation, rather than starving it. If they had acted earlier, far less drastic treatment would now be required. …there is no way around the harsh reality that the bill is coming due for the last two years of monetary malfeasance.

Well said. Easy-money policy is like having six drinks at the bar. The consequences – rising prices, financial bubbles, and recessions – are akin to the hangover.

However, while I agree with the above article, I don’t agree with the title. It should be changed to: “Economies Can’t Avoid the Consequences of Central Bank Actions.”

Why the new title?

For the simple reason that central bankers are actually very capable of dodging responsibility for their mistakes.

For instance, has anyone heard the head of the Federal Reserve, Jerome Powell, apologize for dumping $4 trillion of liquidity into the economy in 2020 and 2021, thus creating today’s big price increases in the United States?

A more glaring example comes from the United Kingdom, where the former Governor of the Bank of England wants to blame Brexit. I’m not joking. Here are some excerpts from a Bloomberg story.

Former Bank of England Governor Mark Carney pointed to Brexit as a key reason why the UK central bank is now having to hike interest rates in its struggle to contain inflation. Alongside rising energy prices and a tight labor market, Britain’s exit from the European Union added to the economic headwinds for the UK, according to Carney. “In the UK, unfortunately, we’ve also had in the near term the impact of Brexit, which has slowed the pace at which the economy can grow,” Carney said in an interview with BBC Radio 4’s “Today” program on Friday. …“The economy’s capacity would go down for a period of time because of Brexit, that would add to inflationary pressure, and we would have a situation, which is the situation we have today, where the Bank of England has to raise interest rates despite the fact the economy is going into recession.”

This is galling.

Brexit did not cause inflation. The finger of blame should be pointed at the Bank of England.

Like the Fed, the BoE dramatically expanded its balance sheet starting in the spring of 2020.

And, like the Fed (and the European Central Bank), it maintained an easy-money policy for the remainder of the year and throughout 2021 – even after it became very clear that the pandemic was not going to cause an economic crisis.

To be fair, Carney left the Bank of England in early 2020, so it’s possible he might not have made the same mistake as Andrew Bailey, who took his place.

But Carney blaming Brexit shows that, if nothing else, he is willing to prevaricate to protect the BoE’s reputation.

What makes his analysis so absurd is that he almost surely would have made the same claims regardless of what happened after Brexit.

• Boris Johnson delivered Brexit, but then proceeded to enact bad policies such as higher taxes and more spending. The economy weakened and Carney says this is why the BoE is being forced to raise interest rates.
• But if Johnson had enacted good policy (the Singapore-on-Thames scenario), the economy would be performing much better. In that case, Carney doubtlessly would have claimed interest rates needed to rise because of overheating.

In reality, of course, interest rates are going up because the BoE is trying to undo its easy-money mistake.

Too bad Carney isn’t man enough to admit what’s really happening. Maybe a woman would be more honest.

P.S. The current Governor of the BoE, Bailey, also likes shifting blame since he wants people to think that Liz Truss’ proposed tax cuts were responsible for financial market instability – even though his easy-money policies are the real culprit.

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European Fiscal Policy Week, Part IV: Bad U.K. Monetary Policy Leads to Bad U.K. Fiscal Policy

I was excited about the possibility of pro-growth tax policy during the short-lived reign of Liz Truss as Prime Minister of the United Kingdom.

However, I’m now pessimistic about the nation’s outlook. Truss was forced to resign and big-government Tories (akin to big-government Republicans) are back in charge.

As part of my “European Fiscal Policy Week,” let’s take a closer look at what happened and analyze the pernicious role of the Bank of England (the BoE is their central bank, akin to the Federal Reserve in the U.S.).

Let’s start with a reminder that the Bank of England panicked during the pandemic and (like the Federal Reserve and the European Central Bank) engaged in dramatic monetary easing.

That was understandable in the spring of 2020, perhaps, but it should have been obvious by the late summer that the world was not coming to an end.

Yet the BoE continued with its easy-money policy. The balance sheet kept expanding all of 2020, even after vaccines became available.

And, as shown by the graph, the easy-money approach continued into early 2021 (and the most-recent figures show the BoE continued its inflationary policy into mid-2021).

Needless to say, all of that bad monetary policy led to bad results. Not only 10 percent annual inflation, but also a financial system made fragile by artificially low interest rates and excess liquidity.

So how does any of this relate to fiscal policy?

As the Wall Street Journal explained in an editorial on October 10, the BoE’s bad monetary policy produced instability in financial markets and senior bureaucrats at the Bank cleverly shifted the blame to then-Prime Minster Truss’ tax plan.

Bank of England Governor Andrew Bailey is trying to stabilize pension funds, which are caught on the shoals of questionable hedging strategies as the high water of loose monetary policy recedes. …The BOE is supposed to be tightening policy to fight inflation at 40-year highs and claims these emergency bond purchases aren’t at odds with its plans to let £80 billion of assets run off its balance sheet over the next year. But BOE officials now seem confused about what they’re doing. …No wonder markets doubt the BOE’s resolve on future interest-rate increases. Undeterred, the bank is resorting to the familiar bureaucratic imperative for self-preservation. Mr. Cunliffe’s letter is at pains to blame Mr. Kwarteng’s fiscal plan for market ructions. His colleagues Jonathan Haskel and Dave Ramsden —all three are on the BOE’s policy-setting committee—have picked up the theme in speeches that blame market turbulence on a “U.K.-specific component.” This is code for Ms. Truss’s agenda. …Mr. Bailey doesn’t help his credibility or the bank’s independence by politicizing the institution.

In a column for Bloomberg, Narayana Kocherlakota also points a finger at the BoE.

And what’s remarkable is that Kocherlakota is the former head of the Minneapolis Federal Reserve and central bankers normally don’t criticize each other.

Markets didn’t oust Truss, the Bank of England did — through poor financial regulation and highly subjective crisis management. …The common wisdom is that financial markets “punished” Truss’s government for its fiscal profligacy. But the chastisement was far from universal. Over the three days starting Sept. 23, when the Truss government announced its mini-budget, the pound fell by 2.2% relative to the euro, and the FTSE 100 stock index declined by 2.2% — notable movements, but hardly enough to bring a government to its knees. The big change came in the price of 30-year UK government bonds, also known as gilts, which experienced a shocking 23% drop. Most of this decline had nothing to do with rational investors revising their beliefs about the UK’s long-run prospects. Rather, it stemmed from financial regulators’ failure to limit leverage in UK pension funds. …The Bank of England, as the entity responsible for overseeing the financial system, bears at least part of the blame for this catastrophe. …the Truss government…was thwarted not by markets, but by a hole in financial regulation — a hole that the Bank of England proved strangely unwilling to plug.

Last but not least, an October 18 editorial by the Wall Street Journal provides additional information.

When the history of Britain’s recent Trussonomics fiasco is written, make sure Bank of England Governor Andrew Bailey gets the chapter he deserves. …The BOE has been late and slow fighting inflation… Mr. Bailey’s actions in the past month have also politicized the central bank…in a loquacious statement that coyly suggested the fiscal plan would be inflationary—something Mr. Kwarteng would have disputed. …Meanwhile, members of the BOE’s policy-setting committee fanned out to imply markets might be right to worry about the tax cuts. If this was part of a strategy to influence fiscal policy, it worked. …Mr. Bailey may have been taking revenge against Ms. Truss, who had criticized the BOE for its slow response to inflation as she ran to be the Conservative Party leader this summer. Her proposed response was to consider revisiting the central bank’s legal mandate. The BOE’s behavior the past month has proven her right beyond what she imagined.

So what are the implications of the BoE’s responsibility-dodging actions?

• First, we should learn a lesson about the importance of good monetary policy. None of this mess would have happened if the BoE had not created financial instability with an inflationary approach.
• Second, we should realize that there are downsides to central bank independence. Historically, being insulated from politics has been viewed as the prudent approach since politicians can’t try to artificially goose an economy during election years. But Bailey’s unethical behavior shows that there is also a big downside.

Sadly, all of this analysis does not change the fact that tax cuts are now off the table in the United Kingdom. Indeed, the new Prime Minister and his Chancellor of the Exchequer have signaled that they will continue Boris Johnson’s pro-tax agenda.

That’s very bad news for the United Kingdom.

P.S. There used to be at least one sensible central banker in the United Kingdom.

P.P.S. But since sensible central bankers are a rare breed, maybe the best approach is to get government out of the business of money.

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Understanding Inflation and the Federal Reserve

Today’s column is about inflation and I want to start by recycling this clip from an interview back in April.

The main message is that the Federal Reserve deserves the blame for inflation.

America’s central bank created dramatically expanded its balance sheet starting in early 2020. This meant lots of extra liquidity sloshing around the economy and that inevitably led to rising prices.

As Milton Friedman explained, inflation is “always and everywhere on monetary phenomenon.”

So why am I regurgitating this type of analysis? Because someone sent me a PolitiFact article from April that supposedly does a “fact check” on the claim that Biden’s spending contributed to inflation.

What shocked me is that the article never mentions the Federal Reserve or monetary policy. I’m not joking.

We decided to look at how much of an impact Biden’s spending had on prices. …some economists, including Larry Summers, a top official under President Barack Obama, warned that the bill would lead to inflation. Fiscal conservatives joined in the warning. …How much of this can be put at Biden’s feet? Some, but not all of it, experts say. …The post-COVID-19 inflation story is more complicated than just federal spending. Other forces, including changes in the labor market, rising global energy and commodity prices, supply chain dysfunction and the war in Ukraine have all contributed to higher prices. …Russia’s attack on Ukraine disrupted a world economy that was still sorting itself out after COVID. Sanctions aimed at cutting Russia’s energy revenues sent oil and gas prices soaring. The war’s crippling hit on Ukraine’s agricultural sector, combined with sanctions (Russia is a major wheat producer), has raised the prices of basic goods like wheat and sunflower oil. …none of the experts we reached, liberal and conservative, said Biden’s actions were responsible for all of the inflation. Past government spending, COVID’s disruptions to labor markets, energy prices and supply-chains also played significant roles. Most recently, the war in Ukraine has made a challenging situation worse.

This is nonsense. At the risk of being boring and wonky, the factors mentioned in the article are important, but they will only change relative prices in the absence of bad monetary policy.

In other words, energy prices may increase, but that will be offset by declines in other prices. Unless, of course, the central bank is creating too much liquidity, thus enabling an increase in the overall price level.

I’ll close with a caveat. Bad monetary policy sometimes will cause rising asset prices (a bubble) rather than rising consumer prices. Both outcomes are examples of inflation, but only the latter shows up when the government releases monthly data on the consumer price index.

That being said, is it possible that some of Biden’s (and Trump’s) spending policies led to more price inflation rather than more asset inflation?

Yes, but that’s merely shifting the deck chairs on the monetary Titanic. And it doesn’t change the fact that it is gross economic malpractice for PolitiFact to write about inflation without mentioning the Federal Reserve or monetary policy.

P.S. Here’s a humorous video about the Federal Reserve and here’s a serious tutorial video about the Federal Reserve.

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Inflation Is Caused by Bad Government Policy

Milton Friedman wisely observed that inflation is always the result of bad monetary policy by central banks. And I echoed that point last month in remarks to the European Resource Bank meeting in Stockholm.

This topic deserves more attention, particularly given the depressing inflation numbers just released this morning by the Bureau of Labor Statistics.

Some of our friends on the left want to downplay these bad numbers. In large part, they are motivated by a desire to shield President Biden from political damage. And I sympathize with them since Biden was not in the White House when the Federal Reserve decided to dump lots of liquidity into the U.S. economy.

Here’s a chart showing the Federal Reserve’s balance sheet over the past decade. It’s easy to see the Fed’s panicked response to the pandemic in early 2020.

But I don’t sympathize with folks who claim that inflation is just something random.

Some of them want to blame Putin. Or the pandemic. Or “corporate greed.” Or maybe even space aliens.

I also wonder about this tweet from Ian Bremmer. He points out that inflation is showing up everywhere, regardless of which political party (or coalition) is running a government.

But I can’t tell what he means by his final line (“wild guess it’s not the govt”).

Is he saying that we should focus on the actions of central banks, not the partisan composition of a nation’s government? If so, I agree.

Or is he saying that we should not blame any part of government? If so, I completely disagree.

Central banks may have varying levels of day-to-day independence, but they are government entities. They were created by politicians and run by people appointed by politicians.

And inflation is happening in many nations because various central banks all made similar mistakes.

For instance, Bremmer mentions Germany and Italy. Those are euro countries and you can see that the European Central Bank made the same mistake as the Fed. It panicked at the start of the pandemic and then never fixed its mistake.

Bremmer also mentioned the United Kingdom. Well, here’s the balance sheet data from the Bank of England.

Once again, you can see a big spike in the amount of liquidity created when the BoE expanded its balance sheet.

And, just as was the case with the Fed and the ECB, the BoE did not fix its mistake once it became apparent than the pandemic was not going to cause a global economic collapse.

P.S. I suggested in the video that the ECB is partly motivated by a desire to prop up decrepit welfare states in nations such as Italy and Greece. This is a point I’ve been warning about for many, many years.

P.P.S. While Biden is not to blame for the outbreak of inflation, it’s also true that he is not part of the solution and has not used his appointment power to push the Fed in a more sensible direction.

P.P.P.S. If you have the time and interest, here’s a 40-minute video explaining the Federal Reserve’s track record of bad monetary policy.

P.P.P.P.S. If you’re constrained for time, I recommend this five-minute video on alternatives to the Federal Reserve and this six-minute video on how people can protect themselves from bad monetary policy.

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The European Central Bank: Subsidizing Profligacy, Creating Bubbles

Earlier this year, I pointed out that President Biden should not be blamed for rising prices.

There has been inflation, of course, but the Federal Reserve deserves the blame. More specifically, America’s central bank responded to the coronavirus pandemic by dumping a lot of money into the economy beginning in early 2020.

Nearly a year before Biden took office.

The Federal Reserve is not the only central bank to make this mistake.

Here’s the balance sheet for the Eurosystem (the European Central Bank and the various national central banks that are in charge of the euro currency). As you can see, there’s also been a dramatic increase in liquidity on the other side of the Atlantic Ocean.

Why should American readers care about what’s happening with the euro?

In part, this is simply a lesson about the downsides of bad monetary policy. For years, I’ve been explaining that politicians like easy-money policies because they create “sugar highs” for an economy.

That’s the good news.

The bad news is that false booms almost always are followed by real busts.

But this is more than a lesson about monetary policy. What’s happened with the euro may have created the conditions for another European fiscal crisis (for background on Europe’s previous fiscal crisis, click here, here, and here).

In an article for Project Syndicate, Willem Buiter warns that the European Central Bank sacrificed sensible monetary policy by buying up the debt of profligate governments.

…major central banks have engaged in aggressive low-interest-rate and asset-purchase policies to support their governments’ expansionary fiscal policies, even though they knew such policies were likely to run counter to their price-stability mandates and were not necessary to preserve financial stability. The “fiscal capture” interpretation is particularly convincing for the ECB, which must deal with several sovereigns that are facing debt-sustainability issues. Greece, Italy, Portugal, and Spain are all fiscally fragile. And France, Belgium, and Cyprus could also face sovereign-funding problems when the next cyclical downturn hits.

Mr. Buiter shares some sobering data.

All told, the Eurosystem’s holdings of public-sector securities under the PEPP at the end of March 2022 amounted to more than €1.6 trillion ($1.7 trillion), or 13.4% of 2021 eurozone GDP, and cumulative net purchases of Greek sovereign debt under the PEPP were €38.5 billion (21.1% of Greece’s 2021 GDP). For Portugal, Italy, and Spain, the corresponding GDP shares of net PEPP purchases were 16.4%, 16%, and 15.7%, respectively. The Eurosystem’s Public Sector Purchase Program (PSPP) also made net purchases of investment-grade sovereign debt. From November 2019 until the end of March 2022, these totaled €503.6 billion, or 4.1% of eurozone GDP. In total, the Eurosystem bought more than 120% of net eurozone sovereign debt issuances in 2020 and 2021.

Other experts also fear Europe’s central bank has created more risk.

Two weeks ago, Desmond Lachman of the American Enterprise Institute expressed concern that Italy had become dependent on the ECB.

…the European Central Bank (ECB) is signaling that soon it will be turning off its monetary policy spigot to fight the inflation beast. Over the past two years, that spigot has flooded the European economy with around $4 trillion in liquidity through an unprecedented pace of government bond buying. The end to ECB money printing could come as a particular shock to the Italian economy, which has grown accustomed to having the ECB scoop up all of its government’s debt issuance as part of its Pandemic Emergency Purchase Program. …the country’s economy has stalled, its budget deficit has ballooned, and its public debt has skyrocketed to 150 percent of GDP. …Italy has had the dubious distinction of being a country whose per capita income has actually declined over the past 20 years. …All of this is of considerable importance to the world economic outlook. In 2010, the Greek sovereign debt crisis shook world financial markets. Now that the global economy is already slowing, the last thing that it needs is a sovereign debt crisis in Italy, a country whose economy is some 10 times the size of Greece’s.

Mr. Lachman also warned about this in April.

Over the past two years, the ECB’s bond-buying programs have kept countries in the eurozone’s periphery, including most notably Italy, afloat. In particular, under its €1.85 trillion ($2 trillion) pandemic emergency purchase program, the ECB has bought most of these countries’ government-debt issuance. That has saved them from having to face the test of the markets.

And he said the same thing in March.

The ECB engaged in a large-scale bond-buying program over the past two years…, as did the U.S. Federal Reserve. The size of the ECB’s balance sheet increased by a staggering four trillion euros (equivalent to $4.4 billion), including €1.85 trillion under its Pandemic Emergency Purchasing Program. …The ECB’s massive bond buying activity has been successful in keeping countries in the eurozone’s periphery afloat despite the marked deterioration in their public finances in the wake of the pandemic.

Let’s conclude with several observations.

• First, many European countries are at risk because politicians, year after year, have spent too much money (Italy is just the tip of the iceberg).
• Second, the ECB has enabled much of that spending by buying a lot of the government debt issued by Europe’s profligate nations.
• Third, there’s now a bubble thanks to the combination of bad fiscal policy by national governments and bad monetary policy by the ECB.
• Fourth, some economic misery is unavoidable, but the damage can be limited if governments impose Swiss-style spending caps.
• Fifth, the political elite in Europe do not want spending restraint and instead prefer very bad policies such as “debt mutualization.”

So if politicians won’t adopt good policies and their bad policies won’t work, what’s going to happen?

At some point, national governments will probably default.

That’s an unpleasant outcome, but at least it will stop the bleeding.

Unlike bailouts and easy money, which exacerbate the underlying problems.

P.S. For what it is worth, I do not think a common currency is necessarily a bad idea. That being said, I wonder if the euro can survive Europe’s awful politicians.

P.P.S. While I think Mr. Buiter’s article in Project Syndicate was very reasonable, I’ve had good reason to criticize some of his past analysis.

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Blame the Federal Reserve

Back in 2015, I explained to Neil Cavuto that easy money creates the conditions for a boom-bust cycle.

It’s now 2022 and my argument is even more relevant.

That’s because the Federal Reserve panicked at the start of the pandemic and dumped a massive amount of money into the economy (technically, the Fed increased its balance sheet by purchasing trillions of dollars of government bonds).

As the late, great Milton Friedman taught us, this easy-money, low-interest-rate approach produced the rising prices that are now plaguing the nation.

But that’s only part of the bad news.

The other bad news is that easy-money policy sets the stage for future hard times. In other words, the Fed causes a boom-bust cycle.

Desmond Lachman of the American Enterprise Institute explains how and why the Federal Reserve has put the country in a bad situation.

Better late than never. Today, the Federal Reserve finally took decisive monetary policy action to regain control over inflation that has been largely of its own making. …The Fed’s abrupt policy U-turn is good news in that it reduces the likelihood that we will return to the inflation of the 1970s. However, this does not mean that we will avoid paying a heavy price for the Fed’s past policy mistakes in lost output and employment. …One might well ask what the Fed was thinking last year when it kept interest rates at their zero lower bound and when it let the money supply balloon at its fastest pace in over fifty years at a time especially when the economy was recovering strongly… One might also ask what the Fed thought when it continued to buy $120 billion a month in Treasury bonds and mortgage-backed securities throughout most of last year when the equity and the housing markets were on fire?

The relevant question, he explains, is whether we have a hard landing…or a harder landing.

If the Fed sticks to its program of meaningful interest rate hikes and balance sheet reduction over the remainder of this year, there would seem to be an excellent chance that we do not return to the inflation of the 1970s. However, there is reason to doubt that the Fed will succeed in pushing the inflation genie to the bottle without precipitating a nasty economic recession. One reason for doubting that the Fed will succeed in engineering a soft economic landing is that there is no precedent for the Fed has done so when it has allowed itself to fall as far behind the inflation curve as it has done today. …there is a real risk that higher interest rates might be the trigger that bursts today’s asset and credit market bubbles. Should that indeed happen, we could be in for a tough landing. Milton Friedman was fond of saying that there is no such thing as a free lunch. This is a lesson that the Fed might soon relearn as last year’s economic party gives way to a painful economic slump.

Let’s hope we have a proverbial “soft landing,” but I’m not holding my breath.

Especially with Biden pursuing other bad policies (FWIW, I don’t blame him for today’s price spikes).

P.S. As explained in this video from the Fraser Institute, Friedrich Hayek understood a long time ago that feel-good government intervention leads to a feel-bad economic hangover.

P.P.S. Here’s my video on the Federal Reserve, which also explains that there might be a good alternative.

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Sri Lanka’s Failed Experiment with Modern Monetary Theory

No sensible person wants to copy the big-spending policies of failed welfare states such as Greece.

Unfortunately, many politicians lack common sense (or, more accurately, they are motivated by short-run political ambition rather than what’s in the long-run best interest of their nations).

So if they decide that they politically benefit by spending lots of other people’s money, they have to figure out how to finance that spending.

One option is to use the central bank. In other words, finance big government with the figurative printing press.

This is what’s know as Modern Monetary Theory.

From a theoretical perspective, it’s crazy. And if Sri Lanka is any indication, it’s also crazy based on real-world evidence.

In an article for The Print, based in India, Mihir Sharma looks at that government’s foolish monetary policy.

Cranks are considered cranks for a reason. That is the lesson from Sri Lanka… How did this tiny Indian Ocean nation end up in such straits? …the Rajapaksas turned Sri Lanka’s policymaking over to cranks… The central bank governor at the time, Weligamage Don Lakshman, informed the public during the pandemic that nobody need worry about debt sustainability…since “domestic currency debt…in a country with sovereign powers of money printing, as the modern monetary theorists would argue, is not a huge problem.” Sri Lanka is the first country in the world to reference MMT officially as a justification for money printing. Lakshman began to run the printing presses day and night; his successor at the central bank, Ajith Nivard Cabraal, who also denied the link between printing money and inflation or currency depreciation, continued the policy. …Reality did not take long to set in. By the end of 2021, inflation hit record highs. And, naturally, the clever plan to “increase the proportion of domestic debt” turned out to be impossible… Proponents of MMT will likely say that this was not real MMT, or that Sri Lanka is not a sovereign country as long as it has any foreign debt, or something equally self-serving.

Professor Steve Hanke of Johns Hopkins University also discussed Sri Lanka’s crazy monetary policy in an article for National Review. And he also offered a way to reverse the MMT mistake.

This slow-motion train wreck first began in November 2019 when Gotabaya Rajapaksa won a decisive victory in the country’s presidential elections. …In total control, President Rajapaksa and his brother Mahinda, the prime minister, went on a spending spree that was financed in part by Sri Lanka’s central bank. The results have been economic devastation. The rupee has lost 44 percent of its value since President Rajapaksa took the reins, and inflation, according to my measure, is running at a stunning 74.5 percent per year. …What can be done to end Sri Lanka’s economic crisis? It should adopt a currency board, like the one it had from 1884 to 1950… Most important, the board could not loan money to the fiscal authorities, imposing a hard budget on Ceylon’s fiscal system. The net effect was economic stability — and while stability might not be everything, everything is nothing without stability.

For readers who are not familiar with currency boards, it basically means creating a hard link with another nation’s currency – presumably another nation with a decent history of monetary restraint.

It’s what Hong Kong has with the United States (even though U.S. monetary policy over time has been less than perfect).

A currency board is not quite the same as “dollarization,” which is actually adopting another nation’s currency, but it’s a way of making sure local politicians have one less way of ruining an economy.

Let’s conclude with a story from the U.K.-based Financial Times, written by Tommy Stubbington and Benjamin Parkin. They provide some grim details about Sri Lanka’s plight.

Sri Lanka owes $15bn in bonds, mostly dollar-denominated, of a total $45bn long-term debt, according to the World Bank. It needs to pay about $7bn this year in interest and debt repayments but its foreign reserves have dwindled to less than $3bn. …Sri Lanka has never defaulted and its successive governments have been known for a market-friendly approach. …Sri Lanka has previously entered 16 programmes with the IMF.

By the way, I can’t help but comment about a couple of points in the article.

The reporters claim that Sri Lanka has been “known for a market-friendly approach.”

To be blunt, this is nonsense. I’ve been dealing with international economic policy for decades and no supporter of free markets and limited government has ever claimed the country was anywhere close to being a role model for good policy.

And if you peruse the latest edition of Economic Freedom of the World, you’ll see that Sri Lanka has very low scores, far below Greece and only slightly ahead of Russia.

And you can click here to see that it has always received dismal scores.

But maybe it’s “market-friendly” by the standards of left-leaning journalists.

I also can’t resist noting that Sri Lanka has already received 16 bailouts from the International Monetary Fund, according to the article.

This is further evidence that it’s not a market-oriented nation.

And it’s also evidence that IMF intervention does not make things better. In many cases, it’s akin to sending an arsonist to put out a fire.

P.S. The Mihir Sharma article also discusses the Sri Lankan government’s crazy approach to agriculture.

Last April, the government followed through on a campaign promise to transition Sri Lanka to organic farming by banning the import and use of synthetic fertilizers. More than two-thirds of Sri Lanka’s people are directly or indirectly dependent on agriculture; economists and agronomists warned that a transition to organic farming on that scale would destroy productivity and cause incomes to crash. …Unsurprisingly, the cranks were wrong. The production of rice — the basic component of Sri Lankans’ diet — and of tea — the country’s main export — sank precipitously.

Needless to say, it’s not a good idea for politicians to deliberately hurt a nation’s agriculture sector.

Just like it’s not a good idea for politicians in places like the United States to deliberately subsidize the sector. The right approach is to be like New Zealand and have no policy.

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The Economics of Greed

Looking back on the 2008 financial crisis, it seems clear that much of that mess was caused by bad government policy, especially easy money from the Federal Reserve and housing subsidies from Fannie Mae and Freddie Mac.

Many of my left-leaning friends, by contrast, assert that “Wall Street greed” was the real culprit.

I have no problem with the notion that greed plays a role in financial markets, but people on Wall Street presumably were equally greedy in the 1980s and 1990s. So why didn’t we also have financial crises during those decades?

Isn’t it more plausible to think that one-off factors may have caused markets to go awry?

I took that trip down Memory Lane because of a rather insipid tweet from my occasional sparring partner, Robert Reich. He wants his followers to think that inflation is caused by “corporate greed.”

For what it’s worth, I agree that corporations are greedy. I’m sure that they are happy when they can charge more for their products.

But that’s hardly an explanation for today’s inflation.

After all, corporations presumably were greedy back in 2015. And in 2005. And in 1995. So why didn’t we also have high inflation those years as well?

If Reich understood economics, he could have pointed out that today’s inflation was caused by the Federal Reserve and also absolved Biden by explaining that the Fed’s big mistake occurred when Trump was in the White House.

I don’t expect Reich to believe me, so perhaps he’ll listen to Larry Summers, who also served in Bill Clinton’s cabinet.

But I won’t hold my breath.

As Don Boudreaux has explained, Reich is not a big fan of economic rigor and accuracy.

P.S. Reich also blamed antitrust policy, but we have had supposedly “weak antitrust enforcement” since the 1980s. So why did inflation wait until 2021 to appear?

P.P.S. In addition to being wrong about the cause of the 2008 crisis, my left-leaning friends also were wrong about the proper response to the crisis.

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Don’t Blame Joe Biden for High Inflation

I’m more than happy to condemn Joe Biden for his bad policy proposals, such as higher tax rates, fake stimulus, red tape, and a bigger welfare state.

But as I discuss in this segment from a recent interview, he bears very little blame for today’s high inflation rate.

If you want to know who is responsible for 8.5 percent inflation, the highest in four decades, this chart tells you everything you need to know.

Simply stated, the Federal Reserve has created a lot more money by expanding its balance sheet (which happens, for example, when the central bank purchases government bonds using “open market operations”).

Notice, by the way, that the Fed dramatically expanded its balance sheet beginning in March 2020. That was almost one year before Biden was inaugurated.

At the risk of stating the obvious, Biden does not have the power of time travel. He can’t be at fault for a monetary policy mistake that happened when Trump was president.

That being said, I don’t want anyone to think that Biden believes in good monetary policy.

• Biden has never made any sort of statement favoring monetary restraint by the Fed.
• Neither the president not his senior advisors have urged the Fed to reverse its mistake.
• Biden renominated Jerome Powell to be Chairman of the Fed’s Board of Governors.
• None of Biden’s other nominees to the Federal Reserve have a track record of opposing easy money.

The bottom line is that the Fed almost surely would have made the same mistake in 2020 if Biden was in the White House.

But he wasn’t, so he gets a partial free pass.

P.S. Speaking of time travel, Paul Krugman blamed Estonia’s 2008 recession on spending cuts that took place in 2009.

P.P.S. Here’s my two cents on how people can protect themselves in an inflationary economy.

P.P.P.S. Only one president in my lifetime deserves praise for his approach to monetary policy.

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Blame the Federal Reserve

The good thing about being a policy-driven libertarian is that I don’t feel any need to engage in political spin.

I can praise Democrats who do good things and praise Republicans who do good things. And also criticize members of either party (sadly, that’s a more common task).

It also means I don’t believe in blaming politicians for things that are not their fault. For example, NBC just released a poll showing that Joe Biden has low marks for economic policy.

Some of that is appropriate (his fiscal policy is atrocious, to cite one reason), but I think the answers to this question show that the president is getting a bum rap on one issue.

Why am I letting Biden off the hook about monetary policy?

For the simple reason that the Federal Reserve (the “Fed”) deserves the blame. The central bank’s inflationary policies are the reason that prices are rising.

One can claim that Joe Biden is partly to blame because he recently re-nominated Jay Powell, the current Chairman of the Fed. But, if that’s the case, then Donald Trump also is partly to blame – or even more to blame – because he nominated Powell in the first place.

Moreover, as illustrated by this chart, the Fed’s mistake that led to rising prices occurred in early 2020.

Simply stated, the Fed pumped lots of liquidity into the system. That set the stage for today’s price increases (as Milton Friedman told us, there’s always a lag between decisions about monetary policy and changes in prices).

If you look closely, you’ll notice that this massive monetary intervention began nearly one year before Biden took office.

Given his support for Keynesian fiscal policy, I suspect Biden also believes in Keynesian monetary policy. As such, we presumably would have had the same policy if Biden had been elected in 2016.

In other words, Biden would have been just like Trump. At least on this issue.

But none of that changes the fact that Biden’s actions since becoming president have very little to do with today’s price increases.

Let’s close with a few additional observations about the aforementioned polling results.

• The folks at NBC deserve some criticism for failing to give people the option of choosing the Federal Reserve’s monetary policy. I’m guessing this was because of ignorance rather than bias.
• The people who blamed “corporations increasing prices” obviously didn’t pay attention in their economics classes. Rising prices are a symptom of inflation, not the cause.
• The people who blamed Putin for inflation are even more ignorant. At the risk of stating the obvious, a Russian invasion in February of 2022 obviously wasn’t responsible for rising prices in 2021.

P.S. The inflation-recession cycle caused by bad monetary policy could be avoided if the Fed was constrained by some simple rules.

P.P.S. Or maybe, just maybe, we should reconsider the role of central banks.

P.P.P.S. For what it’s worth, very few politicians have the intelligence and fortitude to support good monetary policy.

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The Most Important Thing to Understand about Inflation

Every few years (2012, 2015, 2019), I warn that easy-money policies by the Federal Reserve are misguided.

But not just because such policies eventually can lead to price inflation, which now has become a problem in the United States.

Bad monetary policy also can lead to asset inflation. In other words, bubbles. And it’s no fun when bubbles burst.

The obvious lesson to be learned is that central banks such as the Fed shouldn’t try to steer the economy with Keynesian-style monetary policy.

I’m motivated to write about this issue because the Washington Post recently invited some people to offer their ideas on how to fight inflation.

Some of the ideas were worthwhile.

• Michael Strain recommended trade liberalization.
• Brian Riedl recommended spending restraint.
• Matt Darling recommended deregulation.

Some of the ideas were bad, or even awful.

• Robert Hockett recommended industrial policy.
• Lauren Melodia recommended government-subsidized child care.
• William Spriggs recommended class-warfare taxation.
• Lindsay Owens recommended antitrust intervention.
• Todd Tucker recommended price controls.

If asked to contribute, what would I have suggested?

Being a curmudgeonly libertarian, I would have channeled the spirit of Milton Friedman and pointed out that bad monetary policy by central banks is the cause of inflation. Simply stated, it is appropriate to blame central banks if there are sustained and permanent increases in the overall price level.

And the only way to fix inflation is for central banks to unwind the policy mistakes that caused the problem in the first place.

Some of the respondents did mention the need for Federal Reserve to rectify its mistakes, so I’m not the only one to think monetary policy is important.

But I’m very fixated on assigning blame where it belongs, so I would not have mentioned any other factor.

For instance, in an article just published by the Austrian Economics Center in Vienna, Robert O’Quinn and I explain that bad fiscal policy does not cause inflation.

Are we seeing higher levels of price inflation because of fiscal profligacy?  Some Republican U.S. Senators and Representatives have blamed this acceleration of price inflation on Biden’s blowout of federal spending. There are many good reasons to criticize Biden’s spending spree. It is not good for the economy to increase the burden of government spending and push for higher tax rates… But that does not necessarily mean deficit spending is inflationary. …Price inflation occurs when the supply of money exceeds the demand for money… Notably, none of the mechanisms that central banks use for monetary policy (buying and selling government securities, setting interest rates paid on reserves, loans to financial institutions, etc) have anything to do with federal spending or budget deficits.  The Fed and other central banks can maintain price stability regardless of whether governments are enacting reckless fiscal policies.

In the article, we cited Japan as an example of a country with huge levels of debt, yet prices are stable.

By contrast, prices are rising in the United States because of Keynesian monetary policies by the Federal Reserve (often with the support of politicians).

What’s causing inflation, if not budget deficits and government debt? …central banks have been pursuing an inflationary policy. But they’ve been pursuing that approach not to finance budget deficits, but instead are motivated by a Keynesian/interventionist viewpoint that it is the role of central banks to “stimulate” the economy and/or prop up the financial market with easy-money policies.

I’ll close by observing that there can be a link between bad fiscal policy and inflation.

In basket-case nations such as Venezuela, Zimbabwe, and Argentina, politicians periodically use central banks to finance some of their excessive spending.

Some governments, particularly in less-developed countries, cannot easily borrow money and they rely on their central banks to finance their budget deficits. And that is clearly inflationary.

Because of changing demographics and poorly designed entitlement programs, it’s possible that the United States and other western nations eventually may get to this point.

Heck, I speculated just a couple of days ago that the European Central Bank may be doing this with Italy.

But the United States hasn’t yet reached that “tipping point.” There are still plenty of investors willing to buy the federal government’s debt (especially since the dollar is the world’s reserve currency).

The bottom line is that we should pursue good fiscal policy because it makes sense. And we should pursue good monetary policy because it makes sense. But the two are not directly connected.

P.S. On the topic of inflation, Ronald Reagan deserves immense praise for standing firm for good policy in the 1980s.

P.P.S. On the topic of the Federal Reserve, the central bank also should be criticized for interfering with the allocation of credit. And financial repression as well.

P.P.P.S. On the topic of basket-case economies, let’s hope that the American policy makers don’t embrace “modern monetary theory.”

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How Can People Protect Themselves from Bad Monetary Policy?

In the libertarian fantasy world, we would have competing private currencies. In the real world, we have a government central bank.

And central banks have a track record of bad monetary policy, so here’s my two cents on how people can try to protect their household finances.

The above video is a clip from a longer presentation I made as part of “Libertarian Solutions,” an online program put together by the folks at Liberty International.

And I should point out that I goofed around the 3:28 mark of the video, when I meant to say “not planning to take it all out in 2009” (a dumb mistake, but not as bad as the time I said “anals” rather than “annals” on live TV).

That correction aside, I was tasked with discussing how people can prosper in spite of bad government policy, and, as you can see, I did not pretend to have any uniquely brilliant investment strategies.

So I focused on explaining the risks of bad monetary policy, especially the way that central banks (and other government policies) create boom-bust cycles in the economy.

If I had more time, I could have talked about additional threats, such as the crackpot idea of “modern monetary theory.”

And I probably should have found some time to explain the notion of “financial repression” since that’s a government policy that has a very direct adverse effect on people trying to build wealth.

One final point. While I’m very hopeful that they may somehow help people protect their personal finances, you’ll notice that I didn’t recommend cryptocurrencies such as Bitcoin. This is for two reasons.

1. I don’t know enough about how they work to competently discuss the issue.
2. I fear that governments will have the power, desire, and ability to squash the market.

Needless to say, I hope I’m wrong about the second point.

P.S. A classical gold standard could block central banks from engaging in bad monetary policy, but returning to that type of system is almost as unlikely as a shift to private currencies.

P.P.S. While I’m obviously not a big fan of the Federal Reserve, other nations have even worse experiences with their central banks, which is why “dollarization” makes sense for many developing countries.

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A Gold Standard vs. the Federal Reserve’s Fiat Money

I’m not a big fan of the Federal Reserve, mostly because of its Keynesian monetary policy.

Incumbent politicians often applaud when the central bank intervenes to create excess liquidity and artificially low interest rates. That’s because the Keynesian approach produces a short-run “sugar high” that seems positive.

But such policies also create boom-bust conditions.

Indeed, the Federal Reserve deserves considerable blame for some of the economy’s worst episodes of the past 100-plus years – most notably the Great Depression, 1970s stagflation, and the 2008 financial crisis.

So what’s the solution?

I’ve previously pointed out that the classical gold standard has some attractive features but is not politically realistic.

But perhaps it’s time to reassess.

In a column for today’s Wall Street Journal, Professors William Luther and Alexander Salter explain the differences between a gold standard and today’s system of fiat money (i.e., a monetary system with no constraints).

Under a genuine gold standard, …Competition among gold miners adjusts the money supply in response to changes in demand, making purchasing power stable and predictable over long periods. The threat of customers redeeming notes and deposits for gold discourages banks from overissuing… Fiat dollars aren’t constrained by the supply of gold or any other commodity. The Federal Reserve can expand the money supply as much or as little as it sees fit, regardless of changes in money demand. When the Fed expands the money supply too much, an unsustainable boom and costly inflation follow.

They then compare the track records of the two systems.

…nearly all economists believe the U.S. economy has performed better under fiat money than it would have with the gold standard. This conventional wisdom is wrong. The gold standard wasn’t perfect, but the fiat dollar has been even worse. …in practice, the Fed has failed to govern the money supply responsibly. Inflation averaged only 0.2% a year from 1790 to 1913, when the Federal Reserve Act passed. Inflation was higher under the Fed-managed gold standard, averaging 2.7% from 1914 to 1971. It has been even higher without the constraint of gold. From 1972 to 2019, inflation averaged 4%. …the Fed…has also become less predictable. In a 2012 article published in the Journal of Macroeconomics, George Selgin, William D. Lastrapes and Lawrence H. White find “almost no persistence in the variance of inflation prior to the Fed’s establishment, and a very high degree of persistence afterwards.” …One might be willing to accept the costs of higher inflation and a less predictable price level if a Fed-managed fiat dollar reduced undesirable macroeconomic fluctuation. But that hasn’t happened. Consider the past two decades. The early 2000s had an unsustainable boom, as the Fed held interest rates too low for too long.

There was also a column on this issue in the WSJ two years ago.

James Grant opined about (the awful) President Nixon’s decision to make Federal Reserve policy completely independent of the gold anchor.

Richard Nixon announced the suspension of the Treasury’s standing offer to foreign governments to exchange dollars for gold, or vice versa, at the unvarying rate of $35 an ounce. The date was Aug. 15, 1971. Ever since, the dollar has been undefined in law. …In the long sweep of monetary history, this is a new system. Not until relatively recently did any central bank attempt to promote full employment and what is called price stability (but is really a never-ending inflation) by issuing paper money and manipulating interest rates. …a world-wide monetary system based on the scientifically informed discretion of Ph.D. economists. The Fed alone employs 700 of them.

But Grant says the gold standard worked reasonably well.

A 20th-century scholar, reviewing the record of the gold standard from 1880-1914, was unabashedly admiring of it: “Only a trifling number of countries were forced off the gold standard, once adopted, and devaluations of gold currencies were highly exceptional. Yet all this was achieved in spite of a volume of international reserves that, for many of the countries at least, was amazingly small and in spite of a minimum of international cooperation . . . on monetary matters.” …Arthur I. Bloomfield wrote those words, and the Federal Reserve Bank of New York published them, in 1959.

The new approach, which Grant mockingly calls the “Ph.D. standard,” gives central bankers discretionary power to do all sorts of worrisome things.

The ideology of the gold standard was laissez-faire; that of the Ph.D. standard (let’s call it) is statism. Gold-standard central bankers bought few, if any, government securities. Today’s central bankers stuff their balance sheets with them. In the gold-standard era, the stockholders of a commercial bank were responsible for the solvency of the institution in which they held a fractional interest. The Ph.D. standard brought the age of the government bailout and too big to fail.

By the way, the purpose of today’s column isn’t to unreservedly endorse a gold standard.

Such as system is very stable in the long run but can lead to short-term inflation or deflation based on what’s happening with the market for gold. And those short-term fluctuations can be economically disruptive.

I was messaging earlier today with Robert O’Quinn, the former Chief Economist at the Department of Labor (who also worked at the Fed) and got this reaction to the Luther-Salter column.

Which is better matching the long-term growth of the economy and the demand for money? The profitability of gold mining or central bank decision-making? A good monetary rule may be better than a classical gold standard. The difficulty is sustaining a good rule.

The ;problem, of course, is that I don’t trust politicians (and their Fed appointees) to follow a good rule.

• Especially in a world where many of them believe in Keynesian boom-bust monetary policy.
• Especially in a world where many of them think the Fed should prop up or bailout Wall Street.
• Especially in a world where many of them might use the central bank to finance big government.
• Especially in a world where many of them support a “war against cash” to empower politicians.

The bottom line is that we have to choose between two imperfect options and decide which one has a bigger downside.

P.S. Since a return to a classical gold standard is highly unlikely (and because the libertarian dream of “free banking” is even more improbable), the best we can hope for is a president who 1) makes good appointments to the Fed, and 2) supports sound-money policies even when it means short-run political pain. We’ve had one president like that in my lifetime.

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The Federal Reserve, Inflation, and Asset Bubbles

Having been exposed to scholars from the Austrian school as a graduate student, I have a knee-jerk suspicion that it’s not a good idea to rely on the Federal Reserve for macroeconomic tinkering.

In this interview from yesterday, I specifically warn that easy money can lead to economically harmful asset bubbles.

 

Since I don’t pretend to be an expert on monetary policy, I’ll do an appeal to authority.

Claudio Borio of the Bank for International Settlements is considered to be one of the world’s experts on the issue.

Here are some excerpts from a study he recently wrote along with three other economists. I especially like what they wrote about the risks of looking solely at the price level as a guide to policy.

The pre-crisis experience has shown that, in contrast to common belief, disruptive financial imbalances could build up even alongside low and stable, or even falling, inflation. Granted, anyone who had looked at the historical record would not have been surprised: just think of the banking crises in Japan, the Asian economies and, going further back in time, the US experience in the run-up to the Great Depression. But somehow the lessons had got lost in translation… And post-crisis, the performance of inflation has repeatedly surprised. Inflation…has been puzzlingly low especially more recently, as a number of economies have been reaching or even exceeding previous estimates of full employment. …the recent experience has hammered the point home, raising nagging doubts about a key pillar of monetary policymaking. …Our conclusion is that…amending mandates to explicitly include financial stability concerns may be appropriate in some circumstances.

Here’s a chart showing that financial cycles and business cycles are not the same thing.

The economists also point out that false booms instigated by easy money can do a lot of damage.

Some recent work with colleagues sheds further light on some of the possible mechanisms at work (Borio et al (2016)). Drawing on a sample of over 40 countries spanning over 40 years, we find that credit booms misallocate resources towards lower-productivity growth sectors, notably construction, and that the impact of the misallocations that occur during the boom is twice as large in the wake of a subsequent banking crisis. The reasons are unclear, but may reflect, at least in part, the fact that overindebtedness and a broken banking system make it harder to reallocate resources away from bloated sectors during the bust. This amounts to a neglected form of hysteresis. The impact can be sizeable, equivalent cumulatively to several percentage points of GDP over a number of years.

Here’s a chart quantifying the damage.

And here’s some more evidence.

In recent work with colleagues, we examined deflations using a newly constructed data set that spans more than 140 years (1870–2013), and covers up to 38 economies and includes equity and house prices as well as debt (Borio et al (2015)). We come up with three findings. First, before controlling for the behaviour of asset prices, we find only a weak association between deflation and growth; the Great Depression is the main exception. Second, we find a stronger link with asset price declines, and controlling for them further weakens the link between deflations and growth. In fact, the link disappears even in the Great Depression (Graph 4). Finally, we find no evidence of a damaging interplay between deflation and debt (Fisher’s “debt deflation”; Fisher (1932)). By contrast, we do find evidence of a damaging interplay between private sector debt and property (house) prices, especially in the postwar period. These results are consistent with the prevalence of supply-induced deflations.

I’ll share one final chart from the study because it certainly suggest that the economy suffered less instability when the classical gold standard was in effect before World War I.

I’m not sure we could trust governments to operate such a system today, but it’s worth contemplating.

P.S. I didn’t like easy money when Obama was in the White House and I don’t like it with Trump in the White House. Indeed, I worry the good economic news we’re seeing now could be partly illusory.

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Trump’s Keynesian Monetary Policy

Being a policy wonk in a political town isn’t easy. I care about economic liberty while many other people simply care about political maneuvering. And the gap between policy advocacy and personality politics has become even larger in the Age of Trump.

One result is that people who should be allies periodically are upset with my columns. Never Trumpers scold me one day and Trump fanboys scold me the next day. Fortunately, I have a very simple set of responses.

• If you would have loudly cheered for a policy under Reagan but oppose a similar policy under Trump, you’re the problem.
• If you would have loudly condemned a policy under Obama but support a similar policy under Trump, you’re the problem.

Today, we’re going to look at an example of the latter.

The New York Times reported today on Trump’s advocacy of easy-money Keynesianism.

President Trump on Friday called on the Federal Reserve to cut interest rates and take additional steps to stimulate economic growth… On Friday, he escalated his previous critiques of the Fed by pressing for it to resume the type of stimulus campaign it undertook after the recession to jump-start economic growth. That program, known as quantitative easing, resulted in the Fed buying more than $4 trillion worth of Treasury bonds and mortgage-backed securities as a way to increase the supply of money in the financial system.

I criticized these policies under Obama, over and over and over again.

If I suddenly supported this approach under Trump, that would make me a hypocrite or a partisan.

I’m sure I have my share of flaws, but that’s not one of them.

Regardless of whether a politician is a Republican or a Democrat, I don’t like Keynesian fiscal policy and I don’t like Keynesian monetary policy.

Simply stated, the Keynesians are all about artificially boosting consumption, but sustainable growth is only possible with policies that boost production.

There are two additional passages from the article that deserve some commentary.

First, you don’t measure inflation by simply looking at consumer prices. It’s quite possible that easy money will result in asset bubbles instead.

That’s why Trump is flat-out wrong in this excerpt.

“…I personally think the Fed should drop rates,” Mr. Trump said. “I think they really slowed us down. There’s no inflation. I would say in terms of quantitative tightening, it should actually now be quantitative easing. Very little if any inflation. And I think they should drop rates, and they should get rid of quantitative tightening. You would see a rocket ship. Despite that, we’re doing very well.”

To be sure, many senior Democrats were similarly wrong when Obama was in the White House and they wanted to goose the economy.

Which brings me to the second point about some Democrats magically becoming born-again advocates of hard money now that Trump is on the other side.

Democrats denounced Mr. Trump’s comments, saying they showed his disregard for the traditional independence of the Fed and his desire to use its powers to help him win re-election. “There’s no question that President Trump is seeking to undermine the…independence of the Federal Reserve to boost his own re-election prospects,” said Senator Ron Wyden of Oregon, the top Democrat on the Finance Committee.

Notwithstanding what I wrote a few days ago, I agree with Sen. Wyden on this point.

Though I definitely don’t recall him expressing similar concerns when Obama was appointing easy-money supporters to the Federal Reserve.

To close, here’s what I said back in October about Trump’s Keynesian approach to monetary policy.

I also commented on this issue earlier this year. And I definitely recommend these insights from a British central banker.

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The Federal Reserve and Boom-Bust Monetary Policy

Back in January, I spoke with Cheddar about market instability and put much of the blame on the Federal Reserve. Simply stated, I fear we have a bubble thanks to years and years (and years and years) of easy money and artificially low interest rates.

To be sure, I also noted that there are other policies that could be spooking financial markets.

But I do think monetary policy is the big threat. Mistakes by the Fed sooner or later cause recessions (and the false booms that are the leading indicator of future downturns).

Mistakes by Congress, by contrast, “merely” cause slower growth.

In this next clip from the interview, I offer guarded praise to the Fed (not my usual position!) for trying to unwind the easy-money policies from earlier this decade and therefore “normalize” interest rates (i.e., letting rates climb to the market-determined level).

For those interested in the downside risks of easy money, I strongly endorse these cautionary observations from a British central banker.

My modest contribution to the discussion was when I mentioned in the interview that we wouldn’t be in the tough position of having to let interest rates climb if we didn’t make the mistake of keeping them artificially low. Especially for such a long period of time.

My motive for addressing this topic today is that Robert Samuelson used his column in the Washington Post to launch an attack against Steve Moore.

Stephen Moore does not belong on the Federal Reserve Board… Just a decade ago, the U.S. and world economies suffered the worst slumps since World War II. What saved us then were the skilled interventions of the Fed under Chairman Ben S. Bernanke… Do we really want Moore to serve as the last bulkhead against an economic breakdown? …as a matter of prudence, we should assume economic reverses. If so, the Fed chief will become a crisis manager. That person should not be Stephen Moore.

I’ve been friends with Steve for a couple of decades, so I have a personal bias.

That being said, I would be arguing that Samuelson’s column is problematic for two reasons even if I never met Steve.

• First, he doesn’t acknowledge that the crisis last decade was caused in large part by easy-money policy from the Fed. Call me crazy, but I hardly think we should praise the central bank for dousing a fire that it helped to start.
• Second, he frets that Steve would be bad in a crisis, which presumably is a time when it might be appropriate for the Fed to be a “lender of last resort.”* But he offers zero evidence that Steve would be opposed to that approach.

For what it’s worth, I actually worry Steve would be too willing to go along with an easy-money approach. Indeed, I look forward to hectoring him in favor of hard money if he gets confirmed.

But this column isn’t about a nomination battle in DC. My role is to educate on public policy.

So let’s close by reviewing some excerpts from a column in the Wall Street Journal highlighting the work of Claudio Borio at the Bank for International Settlements.

In a 2015 paper Mr. Borio and colleagues examined 140 years of data from 38 countries and concluded that consumer-price deflation frequently coincides with healthy economic growth. If he’s right, central banks have spent years fighting disinflation or deflation when they shouldn’t have, and in the process they’ve endangered the economy more than they realize. “By keeping interest rates very, very, very low,” he warns, “you are contributing to the buildup of risks in the financial system through excessive credit growth, through excessive increases in asset prices, that at some point have to correct themselves. So what you have is a financial boom that necessarily at some point will turn into a bust because things have to adjust.” …It’s not that other economists are blind to financial instability. They’re just strangely unconcerned about it. “There are a number of proponents of secular stagnation who acknowledge, very explicitly, that low interest rates create problems for the future because they’re generating all these financial booms and busts,” Mr. Borio says. Yet they still believe central banks must set ultralow short-term rates to support economic growth—and if that destabilizes the financial system, it’s the will of the economic gods.

Amen. I also recommend this column and this column for further information on how central bankers are endangering prosperity.

P.S. For a skeptical history of the Federal Reserve, click here. If you prefer Fed-mocking videos, click here and here.

P.P.S. I fear the European Central Bank has the same misguided policy. To make matters worse, policy makers in Europe have used easy money as an excuse to avoid the reforms that are needed to generate real growth.

P.P.P.S. Samuelson did recognize that defeating inflation was one of Reagan’s great accomplishments.

*For institutions with liquidity problems. Institutions with solvency problems should be shut down using the FDIC-resolution approach.

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The Economy Is Faltering and Trump’s Protectionism and Weakness on Spending Deserve Part of the Blame

In this interview yesterday, I noted that there are “external” risks to the economy, most notably the spillover effect of a potential economic implosion in China or a fiscal crisis in Italy.

But many of the risks are homegrown, such as Trump’s self-destructive protectionism and the Federal Reserve’s easy money.

Regarding trade, Trump is hurting himself as well as the economy. He simply doesn’t understand that trade is good for prosperity and that trade deficits are largely irrelevant.

Regarding monetary policy, I obviously don’t blame Trump for the Fed’s easy money policy during the Obama years, though I wish that he wouldn’t bash the central bank and instead displayed Reagan’s fortitude about accepting the need to unwind such mistakes.

The interview wasn’t that long, but I had a chance to pontificate on additional topics.

• Economists are lousy forecasters.
• On trade, I’m especially worried about Trump pulling America out of the WTO and/or imposing big trade taxes on the auto sector.
• The reduction in the corporate tax rate is the crowing achievement of the Trump presidency.
• Trump’s track record on government spending is very anemic.
• Trump says a border wall is needed for national security, yet he’s weaker on spending than Franklin Roosevelt and Harry Truman.
• The Trump tax plan does reduce revenue in the short run, but we could still quickly balance the budget with modest spending restraint.
• Government spending is not “juice” for the economy. Federal outlays merely divert resources from the productive sector.

The bottom line is that Trump has a very mixed record on the economy. But I fear the good policies are becoming less important and the bad policies are becoming more prominent.

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Keynesian Monetary Policy: A Recipe for False Booms and Real Busts

I periodically explain that you generally don’t get a recession by hiking taxes, adding red tape, or increasing the burden of government spending. Those policies are misguided, to be sure, but they mostly erode the economy’s long-run potential growth.

If you want to assign blame for economic downturns, the first place to look is monetary policy.

When central banks use monetary policy to keep interest rates low (“Keynesian monetary policy,” but also known as “easy money” or “quantitative easing”), that can cause economy-wide distortions, particularly because capital gets misallocated.

And this often leads to a recession when this “malinvestment” gets liquidated.

I’ve made this point in several recent interviews, and I had a chance to make the same point yesterday.

By the way, doesn’t the other guest have amazing wisdom and insight?

But let’s not digress.

Back to the main topic, I’m not the only one who is worried about easy money.

Desmond Lachman of the American Enterprise Institute is similarly concerned.

Never before have the world’s major central banks kept interest rates so low for so long as they have done over the past decade. More importantly yet, never before have these banks increased their balance sheets on anything like the scale that they have done since 2008 by their aggressive bond-buying programmes. Indeed, since 2008, the size of the combined balances sheet of the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England has increased by a mind-boggling US$10tn. …in recent years, if anything central bank monetary policy might have been overly aggressive. By causing global asset price inflation as well as the serious mispricing and misallocation of global credit, the seeds might have been sown for another Lehman-style economic and financial market crisis down the road. …the all too likely possibility that, by having overburdened monetary policy with the task of stabilizing output, advanced country governments might very well have set us up for the next global boom-bust economic cycle.

If you want the other side of the issue, the Economist is more sympathetic to monetary intervention.

And if you want a very learned explanation of the downsides of easy money, I shared some very astute observations from a British central banker back in 2015.

The bottom line is that easy money – sooner or later – backfires.

By the way, here’s a clip from earlier in the interview. Other than admitting that economists are lousy forecasters, I also warned that the economy is probably being hurt by Trump’s protectionism and his failure to control the growth of spending.

P.S. The “war on cash” in many nations is partly driven by those who want the option of easy money.

P.P.S. I worry that politicians sometimes choose to forgo good reforms because they hope easy money can at least temporarily goose the economy.

P.P.P.S. Easy money is also a tool for “financial repression,” which occurs when governments surreptitiously confiscate money from savers.

P.P.P.P.S. Maybe it’s time to reconsider central banks?

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What Will Cause the Next Recession?

I often discuss the importance of long-run growth and I pontificate endlessly about the policies that will produce better economic performance.

But what about short-term fluctuations? Where are we in the so-called business cycle? I don’t think economists are good at forecasting the ups and downs of the economy, but I did mention the factors that might contribute to a downturn in this interview with Dana Loesch.

Dana isn’t the only one interested in this topic.

The New York Times opined today about the state of the economy.

…the American economy has a lot more power…, and it’s making a lot of noise. …While Mr. Trump praised himself effusively…the stock market seemed unimpressed. …That’s because if you look down the line, there are few clear reasons to be so enthusiastic.

I suspect the editors at the NYT are somewhat motivated by a desire to make Trump look bad, but I don’t necessarily disagree with some of their analysis.

Though I think they are wrong on tax policy, which is the best thing that’s happened since Trump took office.

…the initial jolt of the Republicans’ $1.5 trillion tax cuts, mostly for corporations and the wealthy, is wearing off. Corporations have bought back $437 billion of their own shares, which leaves them that much less to invest in new production, or wages.

By the way, there’s nothing wrong with stock buybacks. It’s a way for companies to return profits to shareholders. And those shareholders generally then reinvest the money, so the NYT screwed up on that bit of analysis.

But they raise a very legitimate issue when looking at the impact of monetary policy.

Then there’s the flattening yield curve, which the St. Louis Federal Reserve’s president, James Bullard, warns could invert late this year if current conditions persist. That means short-term rates, such as those for two-year Treasury bonds, run higher than long-term rates, like the 10-year bond, a sign of pessimism that is a well-known red flag.

Though I would add that we wouldn’t be in the position of having to raise rates if the Fed hadn’t pushed rates artificially low in the first place (the same mistake they made last decade, by the way).

In other words, the best way of avoiding “tight money” is to not engage in periods of “easy money.”

The NYT editorial also looks at consumer spending, which is fine if the goal is to see whether retailers are happy. But if the issue is whether the economy is doing well, it’s much more important to see whether personal income is rising or falling.

Consumers were in a spending mood this spring, an attitude that won’t necessarily continue. …A recent Reuters analysis found that the bottom 60 percent of income-earners have been fueling their spending, and thus the economy’s, by using their savings or credit cards. They almost have to, because wage growth is expanding at a disappointing 2.7 percent annual clip.

I fully agree with this excerpt about trade. Assuming he wants to run for reelection, Trump is being very foolish to push for more protectionism.

…consider the administration’s effort to apply the sledgehammer to the economy’s toes via a trade war and ensuing tariffs on imported steel and aluminum, among other products. …Not only have the tariffs contributed to $1 billion in higher costs for General Motors, they are now contributing to rising prices of everything from Cokes to vacuum cleaners as companies pass along those costs to consumers.

Last but not least, I don’t necessarily agree that expansion have to end. After all, the economy is largely capable of self-correcting.

But a “business cycle” is probably inevitable so long as government has so much power to intervene.

None of these issues by themselves will put the brakes on an economy that is powering along with a 3.9 percent unemployment rate. But the friction is building. …economic expansions — and this one is in its 10th year — eventually run out of gas. …Mr. President, while you like to take credit for positive economic trends that are well beyond your control, you will own the downside, too.

For what it’s worth, I think misguided monetary policy usually deserves blame for short-run economic instability.

I mentioned in the interview that the central bank is trying to “normalize” interest rates. I hope the Fed is successful, though I worry that financial markets (and housing markets) have become dependent on easy money and will take a hit.

I’ll close by pointing out that the pundit class is focusing on whether the economy is growing faster under Trump than it grew under Obama.

I don’t care about that contest. I’m much more interested in whether we can get the kind of free market-driven prosperity we enjoyed under Ronald Reagan or Bill Clinton.

We didn’t get that growth during the Obama years.

And given Trump’s schizophrenic approach to policy, I don’t have high hopes we’ll average 3 percent-plus growth during his tenure.

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What’s Happening with the Economy, Strong Growth or False Boom?

During the Obama years, I used data from the Minneapolis Federal Reserve to explain that the economic recovery was rather weak. And when people responded by pointing to a reasonably strong stock market, I expressed concern that easy-money policies might be creating an artificial boom.

Now that Trump’s in the White House, some policies are changing. On the plus side, we got some better-than-expected tax reform. Moreover, the onslaught of red tape from the Obama years has abated, and we’re even seeing some modest moves to reduce regulation.

But there’s also been bad news. Trump’s bad protectionist rhetoric is now turning into bad policy. And his track record on spending is very discouraging.

What’s hard to pin down, though, is the impact of monetary policy. The Federal Reserve apparently is in the process of slowly unwinding the artificially low interest rates that were part of its easy-money approach. Is this too little, too late? Is it just right? What’s the net effect?

Since economists are lousy forecasters, I don’t pretend to know the answer, but I think we should worry about the legacy impact of all the easy money, which is the point I made in this clip from a recent interview.

James Pethokoukis from the American Enterprise Institute has similar concerns.

Here’s some of what he recently wrote on the topic.

…this supposed “boom” looks more like same-old, same-old. First quarter GDP, for instance, was just revised down two ticks to 2% and monthly job growth is a bit weaker than under President Obama’s final few years. …What’s more, pretty much every recession for a century has been accompanied by some magnitude of explicit Fed tightening. And, of course, the Fed is now well into a tightening cycle. …Another complicating factor is the Trump trade policy, which seems to be a market suppressant right now, if not yet a significant economic one.

Those are all good points, though we still don’t know the answer.

I’ll close with two observations.

• First, our main concern should be boosting the economy’s long-run growth rate, and that’s why we need lower tax rates, less government spending, open trade, and less red tape. As I’ve noted already, Trump has a mixed track record.
• Second, a short-run concern is whether the Federal Reserve’s easy-money policy in recent years has created a bubble that is poised to burst. If it does, Trump will take the blame simply because he happens to be in the White House.

And that second issue gives me an excuse to re-emphasize that Keynesian monetary policy is just as foolish as Keynesian fiscal policy. You may enjoy a “sugar high” for a period of time, but eventually there’s a painful reckoning.

P.S. For what it’s worth, we’d have more growth and stability if policymakers learned from the “Austrian School” of economics.

P.P.S. Moreover, it’s a good idea to be skeptical about the Federal Reserve.

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Anti-Economics from The Economist

When I was younger, folks in the policy community joked that BusinessWeek was the “anti-business business weekly” because its coverage of the economy was just as stale and predictably left wing as what you would find in the pages of Time or Newsweek.

Well, perhaps it’s time for The Economist to be known as the “anti-economics economic weekly.”

Writing about the stagnation that is infecting western nations, the magazine beclowns itself by regurgitating stale 1960s-style Keynesianism. The article is worthy of a fisking (i.e., a “point-by-point debunking of lies and/or idiocies”), starting with the assertion that central banks saved the world at the end of last decade.

During the financial crisis the Federal Reserve and other central banks were hailed for their actions: by slashing rates and printing money to buy bonds, they stopped a shock from becoming a depression.

I’m certainly open to the argument that the downturn would have been far worse if the banking system hadn’t been recapitalized (even if it should have happened using the “FDIC-resolution approach” rather than via corrupt bailouts), but that’s a completely separate issue from whether Keynesian monetary policy was either desirable or successful.

Regarding the latter question, just look around the world. The Fed has followed an easy-money policy. Has that resulted in a robust recovery for America? The European Central Bank (ECB) has followed the same policy. Has that worked? And the Bank of Japan (BoJ) has done the same thing. Does anyone view Japan’s economy as a success?

At least the article acknowledges that there are some skeptics of the current approach.

The central bankers say that ultra-loose monetary policy remains essential to prop up still-weak economies and hit their inflation targets. …But a growing chorus of critics frets about the effects of the low-rate world—a topsy-turvy place where savers are charged a fee, where the yields on a large fraction of rich-world government debt come with a minus sign, and where central banks matter more than markets in deciding how capital is allocated.

The Economist, as you might expect, expresses sympathy for the position of the central bankers.

In most of the rich world inflation is below the official target. Indeed, in some ways central banks have not been bold enough. Only now, for example, has the BoJ explicitly pledged to overshoot its 2% inflation target. The Fed still seems anxious to push up rates as soon as it can.

The preceding passage is predicated on the assumption that there is a mechanistic tradeoff between inflation and unemployment (the so-called Phillips Curve), one of the core concepts of Keynesian economics. According to adherents, all-wise central bankers can push inflation up if they want lower unemployment and push inflation down if they want to cool the economy.

This idea has been debunked by real world events because inflation and unemployment simultaneously rose during the 1970s (supposedly impossible according the Keynesians) and simultaneously fell during the 1980s (also a theoretical impossibility according to advocates of the Phillips Curve).

But real-world evidence apparently can be ignored if it contradicts the left’s favorite theories.

That being said, we can set aside the issue of Keynesian monetary policy because the main thrust of the article is an embrace of Keynesian fiscal policy.

…it is time to move beyond a reliance on central banks. …economies need succour now. The most urgent priority is to enlist fiscal policy. The main tool for fighting recessions has to shift from central banks to governments.

As an aside, the passage about shifting recession fighting “from central banks to governments” is rather bizarre since the Fed, the ECB, and the BoJ are all government entities. Either the reporter or the editor should have rewritten that sentence so that it concluded with “shift from central banks to fiscal policy” or something like that.

In any event, The Economist has a strange perspective on this issue. It wants Keynesian fiscal policy, yet it worries about politicians using that approach to permanently expand government. And it is not impressed by the fixation on “shovel-ready” infrastructure spending.

The task today is to find a form of fiscal policy that can revive the economy in the bad times without entrenching government in the good. …infrastructure spending is not the best way to prop up weak demand. …fiscal policy must mimic the best features of modern-day monetary policy, whereby independent central banks can act immediately to loosen or tighten as circumstances require.

So The Economist endorses what it refers to as “small-government Keynesianism,” though that’s simply its way of saying that additional spending increases (and gimmicky tax cuts) should occur automatically.

…there are ways to make fiscal policy less politicised and more responsive. …more automaticity is needed, binding some spending to changes in the economic cycle. The duration and generosity of unemployment benefits could be linked to the overall joblessness rate in the economy, for example.

In the language of Keynesians, such policies are known as “automatic stabilizers,” and there already are lots of so-called means-tested programs that operate this way. When people lose their jobs, government spending on unemployment benefits automatically increases. During a weak economy, there also are automatic spending increases for programs such as Food Stamps and Medicaid.

I guess The Economist simply wants more programs that work this way, or perhaps bigger handouts for existing programs. And the magazine views this approach as “small-government Keynesianism” because the spending increases theoretically evaporate as the economy starts growing and fewer people are automatically entitled to receive benefits from the various programs.

Regardless, whoever wrote the article seems convinced that such programs help boost the economy.

When the next downturn comes, this kind of fiscal ammunition will be desperately needed. Only a small share of public spending needs to be affected for fiscal policy to be an effective recession-fighting weapon.

My reaction, for what it’s worth, is to wonder why the article doesn’t include any evidence to bolster the claim that more government spending is and “effective” way of ending recessions and boosting growth. Though I suspect the author of the article didn’t include any evidence because it’s impossible to identify any success stories for Keynesian economics.

• Did Keynesian spending boost the economy under Hoover? No.
• Did Keynesian spending boost the economy under Roosevelt? No.
• Has Keynesian spending worked in Japan at any point over the past twenty-five years? No.
• Did Keynesian spending boost the economy under Obama? No.

Indeed, Keynesian spending has an unparalleled track record of failure in the real world. Though advocates of Keynesianism have a ready-built excuse. All the above failures only occurred because the spending increases were inadequate.

But what do expect from the “perpetual motion machine” of Keynesian economics, a theory that is only successful if you assume it is successful?

I’m not surprised that politicians gravitate to this idea. After all, it tells them that their vice  of wasteful overspending is actually a virtue.

But it’s quite disappointing that journalists at an allegedly economics-oriented magazine blithely accept this strange theory.

P.S. My second-favorite story about Keynesian economics involves the sequester, which big spenders claimed would cripple the economy, yet that’s when we got the only semi-decent growth of the Obama era.

P.P.S. My favorite story about Keynesianism is when Paul Krugman was caught trying to blame a 2008 recession in Estonia on spending cuts that occurred in 2009.

P.P.P.S. Here’s my video explaining Keynesian economics.

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Japan’s Slow-Motion Fiscal and Monetary Suicide

Remember Bill Murray’s Groundhog Day, the 1993 comedy classic about a weatherman who experiences the same day over and over again?

Well, the same thing is happening in Japan. But instead of a person waking up and reliving the same day, we get politicians pursuing the same failed Keynesian stimulus policies over and over again.

The entire country has become a parody of Keynesian economics. Yet the politicians make Obama seem like a fiscal conservative by comparison. They keep doubling down on the same approach, regardless of all previous failures.

The Wall Street Journal reports on the details of the latest Keynesian binge.

Japan’s cabinet approved a government stimulus package that includes ¥7.5 trillion ($73 billion) in new spending, in the latest effort by Prime Minister Shinzo Abe to jump-start the nation’s sluggish economy. The spending program, which has a total value of ¥28 trillion over several years, represents…an attempt to breathe new life into the Japanese economy… The government will pump money into infrastructure projects… The government will provide cash handouts of ¥15,000, or about $147, each to 22 million low-income people… Other items in the package included interest-free loans for infrastructure projects…and new hotels for foreign tourists.

As already noted, this is just the latest in a long line of failed stimulus schemes.

The WSJ story includes this chart showing what’s happened just since 2008.

And if you go back farther in time, you’ll see that the Japanese version of Groundhog Day has been playing since the early 1990s.

Here’s a list, taken from a presentation at the IMF, of so-called stimulus plans adopted by various Japanese governments between 1992-2008.

And here’s my contribution to the discussion. I went to the IMF’s World Economic Outlook database and downloaded the numbers on government borrowing, government debt, and per-capita GDP growth.

I wanted to see how much deficit spending there was and what the impact was on debt and the economy. As you can see, red ink skyrocketed while the private economy stagnated.

Though we shouldn’t be surprised. Keynesian economics didn’t work for Hoover and Roosevelt, or Bush and Obama, so why expect it to work in another country.

By the way, I can’t resist making a comment on this excerpt from a CNBC report on Japan’s new stimulus scheme.

Abe ordered his government last month to craft a stimulus plan to revive an economy dogged by weak consumption, despite three years of his “Abenomics” mix of extremely accommodative monetary policy, flexible spending and structural reform promises.

In the interest of accuracy, the reporter should have replaced “despite” with “because of.”

In addition to lots of misguided Keynesian fiscal policy, there’s been a radical form of Keynesian monetary policy from the Bank of Japan.

Here are some passages from a very sobering Bloomberg report about the central bank’s burgeoning ownership of private companies.

Already a top-five owner of 81 companies in Japan’s Nikkei 225 Stock Average, the BOJ is on course to become the No. 1 shareholder in 55 of those firms by the end of next year…. BOJ Governor Haruhiko Kuroda almost doubled his annual ETF buying target last month, adding to an unprecedented campaign to revitalize Japan’s stagnant economy. …opponents say the central bank is artificially inflating equity valuations and undercutting efforts to make public companies more efficient. …the monetary authority’s outsized presence will make some shares harder to buy and sell, a phenomenon that led to convulsions in Japan’s government bond market this year. …the BOJ doesn’t acquire individual shares directly, it’s the ultimate buyer of stakes purchased through ETFs. …investors worry that BOJ purchases could give a free ride to poorly-run firms and crowd out shareholders who would otherwise push for better corporate governance.

Wow. I don’t pretend to be an expert on monetary economics, but I can’t image that there will be a happy ending to this story.

Just in case you’re not sufficiently depressed about Japan’s economic outlook, keep in mind that the nation also is entering a demographic crisis, as reported by the L.A. Times.

All across Japan, aging villages such as Hara-izumi have been quietly hollowing out for years… Japan’s population crested around 2010 with 128 million people and has since lost about 900,000 residents, last year’s census confirmed. Now, the country has begun a white-knuckle ride in which it will shed about one-third of its population — 40 million people — by 2060, experts predict. In 30 years, 39% of Japan’s population will be 65 or older.

The effects already are being felt, and this is merely the beginning of the demographic wave.

Police and firefighters are grappling with the safety hazards of a growing number of vacant buildings. Transportation authorities are discussing which roads and bus lines are worth maintaining and cutting those they can no longer justify. …Each year, the nation is shuttering 500 schools. …In Hara-izumi, …The village’s population has become so sparse that wild bears, boars and deer are roaming the streets with increasing frequency.

Needless to say (but I’ll say it anyhow), even modest-sized welfare states eventually collapse when you wind up with too few workers trying to support an ever-growing number of recipients.

Now maybe you can understand why I’ve referred to Japan as a basket case.

P.S. You hopefully won’t be surprised to learn that Japanese politicians are getting plenty of bad advice from the fiscal pyromaniacs at the IMF and OECD.

P.P.S. Maybe I’m just stereotyping, but I’ve always assumed the Japanese were sensible people, even if they have a bloated and wasteful government. But when you look at that nation’s contribution to the stupidest-regulation contest and the country’s entry in the government-incompetence contest, I wonder whether the Japanese have some as-yet-undiscovered genetic link to Greece?

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The War against Cash, Part III

Although it doesn’t get nearly as much attention as it warrants, one of the greatest threats to liberty and prosperity is the potential curtailment and elimination of cash.

As I’ve previously noted, there are two reasons why statists don’t like cash and instead would prefer all of us to use digital money (under their rules, of course, not something outside their control like bitcoin).

First, tax collectors can’t easily monitor all cash transactions, so they want a system that would allow them to track and tax every possible penny of our income and purchases.

Second, Keynesian central planners would like to force us to spend more money by imposing negative interest rates (i.e., taxes) on our savings, but that can’t be done if people can hold cash.

To provide some background, a report in the Wall Street Journal looks at both government incentives to get rid of high-value bills and to abolish currency altogether.

Some economists and bankers are demanding a ban on large denomination bills as one way to fight the organized criminals and terrorists who mainly use these notes. But the desire to ditch big bills is also being fueled from unexpected quarter: central bank’s use of negative interest rates. …if a central bank drives interest rates into negative territory, it’ll struggle to manage with physical cash. When a bank balance starts being eaten away by a sub-zero interest rate, cash starts to look inviting. That’s a particular problem for an economy that issues high-denomination banknotes like the eurozone, because it’s easier for a citizen to withdraw and hoard any money they have got in the bank.

Now let’s take a closer look at what folks on the left are saying to the public. In general, they don’t talk about taxing our savings with government-imposed negative interest rates. Instead, they make it seem like their goal is to fight crime.

Larry Summers, a former Obama Administration official, writes in the Washington Post that this is the reason governments should agree on a global pact to eliminate high-denomination notes.

…analysis is totally convincing on the linkage between high denomination notes and crime. …technology is obviating whatever need there may ever have been for high denomination notes in legal commerce. …The €500 is almost six times as valuable as the $100. Some actors in Europe, notably the European Commission, have shown sympathy for the idea and European Central Bank chief Mario Draghi has shown interest as well.  If Europe moved, pressure could likely be brought on others, notably Switzerland. …Even better than unilateral measures in Europe would be a global agreement to stop issuing notes worth more than say $50 or $100.  Such an agreement would be as significant as anything else the G7 or G20 has done in years. …a global agreement to stop issuing high denomination notes would also show that the global financial groupings can stand up against “big money” and for the interests of ordinary citizens.

Summers cites a working paper by Peter Sands of the Kennedy School, so let’s look at that argument for why governments should get rid of all large-denomination currencies.

Illegal money flows pose a massive challenge to all societies, rich and poor. Tax evasion undercuts the financing of public services and distorts the economy. Financial crime fuels and facilitates criminal activities from drug trafficking and human smuggling to theft and fraud. Corruption corrodes public institutions and warps decision-making. Terrorist finance sustains organisations that spread death and fear. The scale of such illicit money flows is staggering. …Our proposal is to eliminate high denomination, high value currency notes, such as the €500 note, the $100 bill, the CHF1,000 note and the £50 note. …Without being able to use high denomination notes, those engaged in illicit activities – the “bad guys” of our title – would face higher costs and greater risks of detection. Eliminating high denomination notes would disrupt their “business models”.

Are these compelling arguments? Should law-abiding citizens be forced to give up cash in hopes of making life harder for crooks? In other words, should we trade liberty for security?

From a moral and philosophical perspective, the answer is no. Our Founders would be rolling in their graves at the mere thought.

But let’s address this issue solely from a practical, utilitarian perspective.

The first thing to understand is that the bad guys won’t really be impacted. The head the The American Anti-Corruption Institute, L. Burke Files, explains to the Financial Times why restricting cash is pointless and misguided.

Peter Sands…has claimed that removal of high-denomination bank notes will deter crime. This is nonsense. After more than 25 years of investigating fraudsters and now corrupt persons in more than 90 countries, I can tell you that only in the extreme minority of cases was cash ever used — even in corruption cases. A vast majority of the funds moved involved bank wires, or the purchase and sale of valuable items such as art, antiquities, vessels or jewellery. …Removal of high denomination bank notes is a fruitless gesture akin to curing the common cold by forbidding use of the term “cold”.

In other words, our statist friends are being disingenuous. They’re trying to exploit the populace’s desire for crime fighting as a means of achieving a policy that actually is designed for other purposes.

The good news, is that they still have a long way to go before achieving their goals. Notwithstanding agitation to get rid of “Benjamins” in the United States, that doesn’t appear to be an immediate threat. Additionally, according to SwissInfo, is that the Swiss government has little interest in getting rid of the CHF1,000 note.

The European police agency Europol, EU finance ministers and now the European Central Bank, have recently made noises about pulling the €500 note, which has been described as the “currency of choice” for criminals. …But Switzerland has no plans to follow suit. “The CHF1,000 note remains a useful tool for payment transactions and for storing value,” Swiss National Bank spokesman Walter Meier told swissinfo.ch.

This resistance is good news, and not just because we want to control rapacious government in North America and Europe.

A column for Yahoo mentions the important value of large-denomination dollars and euros in less developed nations.

Cash also has the added benefit of providing emergency reserves for people “with unstable exchange rates, repressive governments, capital controls or a history of banking collapses,” as the Financial Times noted.

Amen. Indeed, this is one of the reasons why I like bitcoin. People need options to protect themselves from the consequences of bad government policy, regardless of where they live.

By the way, if you’ll allow me a slight diversion, Bill Poole of the University of Delaware (and also a Cato Fellow) adds a very important point in a Wall Street Journal column. He warns that a fixation on monetary policy is misguided, not only because we don’t want reckless easy-money policy, but also because we don’t want our attention diverted from the reforms that actually could boost economic performance.

Negative central-bank interest rates will not create growth any more than the Federal Reserve’s near-zero interest rates did in the U.S. And it will divert attention from the structural problems that have plagued growth here, as well as in Europe and Japan, and how these problems can be solved. …Where central banks can help is by identifying the structural impediments to growth and recommending a way forward. …It is terribly important that advocates of limited government understand what is at stake. …calls for a return to near-zero or even negative interest rates…will do little in the short run to boost growth, but it will dig the federal government into a deeper fiscal hole, further damaging long-run prospects. It needs to be repeated: Monetary policy today has little to offer to raise growth in the developed world.

Let’s close by returning to the core issue of whether it is wise to allow government the sweeping powers that would accompany the elimination of physical currency.

Here are excerpts from four superb articles on the topic.

First, writing for The American Thinker, Mike Konrad argues that eliminating cash will empower government and reduce liberty.

Governments will rise to the occasion and soon will be making cash illegal.  People will be forced to put their money in banks or the market, thus rescuing the central governments and the central banks that are incestuously intertwined with them. …cash is probably the last arena of personal autonomy left. …It has power that the government cannot control; and that is why it has to go. Of course, governments will not tell us the real reasons.  …We will be told it is for our own “good,” however one defines that. …What won’t be reported will be that hacking will shoot up.  Bank fraud will skyrocket. …Going cashless may ironically streamline drug smuggling since suitcases of money weigh too much. …The real purpose of a cashless society will be total control: Absolute Total Control. The real victims will be the public who will be forced to put all their wealth in a centralized system backed up by the good faith and credit of their respective governments.  Their life savings will be eaten away yearly with negative rates. …The end result will be the loss of all autonomy.  This will be the darkest of all tyrannies.  From cradle to grave one will not only be tracked in location, but on purchases.  Liberty will be non-existent. However, it will be sold to us as expedient simplicity itself, freeing us from crime: Fascism with a friendly face.

Second, the invaluable Allister Heath of the U.K.-based Telegraph warns that the desire for Keynesian monetary policy is creating a slippery slope that eventually will give governments an excuse to try to completely banish cash.

…the fact that interest rates of -0.5pc or so are manageable doesn’t mean that interest rates of -4pc would be. At some point, the cost of holding cash in a bank account would become prohibitive: savers would eventually rediscover the virtues of stuffed mattresses (or buying equities, or housing, or anything with less of a negative rate). The problem is that this will embolden those officials who wish to abolish cash altogether, and switch entirely to electronic and digital money. If savers were forced to keep their money in the bank, the argument goes, then they would be forced to put up with even huge negative rates. …But abolishing cash wouldn’t actually work, and would come with terrible side-effects. For a start, people would begin to treat highly negative interest rates as a form of confiscatory taxation: they would be very angry indeed, especially if rates were significantly more negative than inflation. …Criminals who wished to evade tax or engage in illegal activities would still be able to bypass the system: they would start using foreign currencies, precious metals or other commodities as a means of exchange and store of value… The last thing we now need is harebrained schemes to abolish cash. It wouldn’t work, and the public rightly wouldn’t tolerate it.

The Wall Street Journal has opined on the issue as well.

…we shouldn’t be surprised that politicians and central bankers are now waging a war on cash. That’s right, policy makers in Europe and the U.S. want to make it harder for the hoi polloi to hold actual currency. …the European Central Bank would like to ban €500 notes. …Limits on cash transactions have been spreading in Europe… Italy has made it illegal to pay cash for anything worth more than €1,000 ($1,116), while France cut its limit to €1,000 from €3,000 last year. British merchants accepting more than €15,000 in cash per transaction must first register with the tax authorities. …Germany’s Deputy Finance Minister Michael Meister recently proposed a €5,000 cap on cash transactions. …The enemies of cash claim that only crooks and cranks need large-denomination bills. They want large transactions to be made electronically so government can follow them. Yet…Criminals will find a way, large bills or not. The real reason the war on cash is gearing up now is political: Politicians and central bankers fear that holders of currency could undermine their brave new monetary world of negative interest rates. …Negative rates are a tax on deposits with banks, with the goal of prodding depositors to remove their cash and spend it… But that goal will be undermined if citizens hoard cash. …So, presto, ban cash. …If the benighted peasants won’t spend on their own, well, make it that much harder for them to save money even in their own mattresses. All of which ignores the virtues of cash for law-abiding citizens. Cash allows legitimate transactions to be executed quickly, without either party paying fees to a bank or credit-card processor. Cash also lets millions of low-income people participate in the economy without maintaining a bank account, the costs of which are mounting as post-2008 regulations drop the ax on fee-free retail banking. While there’s always a risk of being mugged on the way to the store, digital transactions are subject to hacking and computer theft. …the reason gray markets exist is because high taxes and regulatory costs drive otherwise honest businesses off the books. Politicians may want to think twice about cracking down on the cash economy in a way that might destroy businesses and add millions to the jobless rolls. …it’s hard to avoid the conclusion that the politicians want to bar cash as one more infringement on economic liberty. They may go after the big bills now, but does anyone think they’d stop there? …Beware politicians trying to limit the ways you can conduct private economic business. It never turns out well.

Last, but not least, Glenn Reynolds, a law professor at the University of Tennessee, explores the downsides of banning cash in a column for USA Today.

…we need to restore the $500 and $1000 bills. And the reason is that people like Larry Summers have done a horrible job. …What is a $100 bill worth now, compared to 1969? According to the U.S. Inflation Calculator online, a $100 bill today has the equivalent purchasing power of $15.49 in 1969 dollars. …And although inflation isn’t running very high at the moment, this trend will only continue. If the next few decades are like the last few, paper money in current denominations will become basically useless. …to our ruling class this isn’t a bug, but a feature. Governments want to get rid of cash… But at a time when, almost no matter where you look in the world, the parts of it controlled by the experts and technocrats (like Larry Summers) seem to be doing badly, it seems reasonable to ask: Why give them still more control over the economy? What reason is there to think that they’ll use that control fairly, or even competently? Their track record isn’t very impressive. Cash has a lot of virtues. One of them is that it allows people to engage in voluntary transactions without the knowledge or permission of anyone else. Governments call this suspicious, but the rest of us call it something else: Freedom.

Amen. Glenn nails it.

Banning cash is a scheme concocted by politicians and bureaucrats who already have demonstrated that they are incapable of competently administering the bloated public sector that already exists.

The idea that they should be given added power to extract more of our money and manipulate our spending is absurd. Laughably absurd if you read Mark Steyn.

P.S. I actually wouldn’t mind getting rid of the government’s physical currency, but only if the result was a system that actually enhanced liberty and prosperity. Unfortunately, I don’t expect that to happen in the near future.

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The War against Cash, Part II

I wrote yesterday that governments want to eliminate cash in order to make it easier to squeeze more money from taxpayers.

But that’s not the only reason why politicians are interested in banning paper money and coins.

They also are worried that paper money inhibits the government’s ability to “stimulate” the economy with artificially low interest rates. Simply stated, they’ve already pushed interest rates close to zero and haven’t gotten the desired effect of more growth, so the thinking in official circles is that if you could implement negative interest rates, people could be pushed to be good little Keynesians because any money they have in their accounts would be losing value.

I’m not joking.

Here’s some of what Kenneth Rogoff, a professor at Harvard and a former economist at the International Monetary Fund, wrote for the U.K.-based Financial Times.

Getting rid of physical currency and replacing it with electronic money would…eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash.

And here are some passages from an editorial that also was published in the FT.

…authorities would do well to consider the arguments for phasing out their use as another “barbarous relic”…even a little physical currency can cause a lot of distortion to the economic system. The existence of cash — a bearer instrument with a zero interest rate — limits central banks’ ability to stimulate a depressed economy.

Meanwhile, Bloomberg reports that the Willem Buiter of Citi (the same guy who endorsed military attacks on low-tax jurisdictions) supports the elimination of cash.

Citi’s Willem Buiter looks at this problem, which is known as the effective lower bound (ELB) on nominal interest rates. …the ELB only exists at all due to the existence of cash, which is a bearer instrument that pays zero nominal rates. Why have your money on deposit at a negative rate that reduces your wealth when you can have it in cash and suffer no reduction? Cash therefore gives people an easy and effective way of avoiding negative nominal rates. …Buiter’s solution to cash’s ability to allow people to avoid negative deposit rates is to abolish cash altogether.

So are they right? Should cash be abolished so central bankers and governments have more power to manipulate the economy?

There’s a lot of opposition from very sensible people, particularly in the United Kingdom where the idea of banning cash is viewed as a more serious threat.

Allister Heath of the U.K.-based Telegraph worries that governments would engage in more mischief if a nation got rid of cash.

Many of our leading figures are preparing to give up on sound money. The intervention I’m most concerned about is Bank of England chief economist Andrew Haldane’s call for a 4pc inflation target, as well as his desire to abolish cash, embrace a purely electronic currency and thus make it easier for the Bank to impose substantially negative interest rates… Imagine that banks imposed -4pc interest rates on savings today: everybody would pull cash out and stuff it under their mattresses. But if all cash were digital, they would be trapped and forced to hand over their money. …all spending would become subject to the surveillance state, dramatically eroding individual liberty. …Money is already too loose – turning on the taps would merely further fuel bubbles at home and abroad.

Also writing for the Telegraph, Matthew Lynn expresses reservations about this trend.

As for negative interest rates, do we really want those? Or have we concluded that central bankers are doing more harm than good with their attempts to manipulate the economy? …a banknote is an incredibly efficient way to handle small transactions. It is costless, immediate, flexible, no one ever needs a password, it can’t be hacked, and the system doesn’t ever crash. More importantly, cash is about freedom. There are surely limits to the control over society we wish to hand over to governments and central banks? You don’t need to be a fully paid-up libertarian to question whether…we really want the banks and the state to know every single detail of what we are spending our money on and where. It is easy to surrender that freedom – but it will be a lot harder to get back.

Merryn Somerset Webb, a business writer from the U.K., is properly concerned about the economic implications of a society with no cash.

…at the beginning of the financial crisis, there was much talk about financial repression — the ways in which policymakers would seek to control the use of our money to deal with out-of-control public debt. …We’ve seen capital controls in the periphery of the eurozone… Interest rates everywhere have been at or below inflation for seven years — and negative interest rates are now snaking their nasty way around Europe… This makes debt interest cheap for governments…and it and forces once-prudent savers to move their money into the kind of risky assets that are supposed to drive growth (and tax receipts).

Amen. She’s right that low interest rates are good news for governments and not very good news for people in the productive sector.

Last but not least, Chris Giles wrote a column for the FT and made one final point that is very much worth sharing.

Mr Haldane’s proposal to ban cash has all the hallmarks of a public official confusing what is convenient for the central bank with what is in the public interest.

Especially since the central bankers are probably undermining long-run economic prosperity with short-run tinkering.

Moreover, the option to engage in Keynesian monetary policy also gives politicians an excuse to avoid the reforms that actually would boost economic performance. Indeed, it’s quite likely that an easy-money policy exacerbates the problems caused by bad fiscal and regulatory policy.

Let’s conclude by noting that maybe the right approach isn’t to give politicians and central bankers more control over money, but rather to reduce government’s control over money. That’s one of the arguments I made in this video I narrated for the Center for Freedom and Prosperity.

P.S. By the way, Ryan McKaken at the Mises Institute identifies a third reason why politicians would prefer a cash-free society.

…the elimination of physical cash makes it easier for the state to keep track of private persons, and it assists central banks in efforts to punish saving and expand the money supply by implementing negative interest rate schemes. A third advantage of the elimination of physical cash would be to more easily control people and potential dissidents through the freezing of their bank accounts.

Excellent point. We’ve already seen how asset forfeiture allows governments to steal people’s bank accounts without any conviction of wrongdoing. Imagine the damage politicians and bureaucrats could do if they had even more control over our money.

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Yes, We Should Clip the Wings of the Federal Reserve’s Philosopher Kings

We’ve been suffering through the weakest recovery since the Great Depression. Labor force participation hasn’t recovered and median household income is stagnant.

So how are our benevolent and kind overseers in Washington responding?

Are they reducing the burden of spending? Nope, they just busted the spending caps (again).

Are they cutting back on red tape? No, they’re moving in the other direction.

Are they lowering taxes? With Obama in the White House, that’s not even a serious question.

But that doesn’t mean all the people in Washington is sitting on their collective hands. The folks at the Federal Reserve have been trying to goose the economy with an easy-money policy.

Unfortunately, as I argue in this recent interview, that’s not a recipe for success.

At best, an easy-money policy is ineffective, akin to “pushing on a string.” At worst, it creates bubbles and does serious damage.

Yet if you don’t like the Fed trying to manipulate the economy, you’re often perceived as a crank. And if you’re an elected official who questions the Fed’s actions, you’re often portrayed as some sort of uninformed demagogue.

I explored this issue today in The Federalist. In my column, I defended Senators Rand Paul and Ted Cruz.

Rand Paul and Ted Cruz…deserve credit for criticizing the Federal Reserve. …This irks some folks, who seem to think Fed critics are knuckle-dragging rubes and yahoos with a superstitious fealty to the gold standard.

This isn’t a debate over the gold standard, per se, but instead of fight over monetary Keynesianism vs. monetary rules.

The dispute isn’t really about a gold standard, but whether the Federal Reserve should have lots of discretionary power.  …On one side are the advocates of…the monetary component of Keynesian economics. Proponents explicitly want the Fed to fine-tune and micromanage the economy. …On the other side are folks who believe in rules to limit the Fed’s powers…because they believe discretionary power is more likely to give us bad results such as higher price inflation, volatility in output and employment, and financial instability.

And the Joint Economic Committee is on the side of rules. Here’s an excerpt from a JEC report that I cited in my article.

Well-reasoned, stable and predictable monetary policy reduces economic volatility and promotes long-term economic growth and job creation. Generally, ‘rules-based’ policies reduce uncertainties and facilitate long-term planning and investment. …Conversely, activist, interventionist, and discretionary monetary policies have been historically associated with increased economic volatility and subpar economic performance.

I then mention various rules-based methods of limiting the Fed’s discretion and conclude by commenting on the legitimacy of those who want to curtail the Federal Reserve.

Paul and Cruz may not be experts on monetary policy, just as left-wing senators doubtlessly have no understanding of the intricacies of discretionary monetary policy. But the two senators are on very solid ground, with an illustrious intellectual lineage, when they assert that it would be a good idea to constrain the Fed.

Now let’s expand on two issues. First, I mention in my article the gold standard as a potential rule to constrain the Fed. I’ve previously shared some analysis by George Selgin on this topic. He’s concluded that governments won’t ever allow its return and probably couldn’t be trusted with such a system anyway, but that doesn’t mean it doesn’t work.

Here are some excerpts from a recent article by George. Read the entire thing, but here’s the part that matters most for this discussion.

…the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. …the classical gold standard worked remarkably well (while it lasted). …it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was “normal, certain, and permanent.” The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since.

And Norbert Michel of the Heritage Foundation touches on some of the same issues in a new column for Forbes.

Several candidates suggested the gold standard was a good system, and they’re all getting flak for talking about gold.

But here’s the most fascinating revelation from Norbert’s column. It turns out that even Ben Bernanke agrees with George Selgin that the classical gold standard worked very well. Norbert quotes this passage from Bernanke.

The gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called “classical” gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value.

Both Norbert’s article and George’s article have lots of good (but depressing) analysis of how governments went off the gold standard because of World War I and then put in place a hopelessly weak and impractical version of a gold standard after the war (the politicians didn’t want to be constrained by an effective system).

So here’s Norbert’s bottom line, which is very similar to the conclusion in my column for The Federalist.

Many who favor the gold standard recognize that it provided a nominal anchor as opposed to the discretionary fiat system we have now. Maybe the gold standard isn’t the best way to achieve that nominal anchor, but we shouldn’t just dismiss the whole notion.

The second issue worth mentioning is that the best way to deal with bad monetary policy may be to have no monetary policy.

At least not a monetary policy from government. This video explains the merits of this approach.

Gee, maybe Friedrich Hayek was right and private markets produce better results than government monopolies.

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Bubbles, Easy Money, and Free-Lunch Monetary Policy

What’s the biggest economic fallacy on the left? What’s the defining mistake for our statist friends?

One obvious answer is that many of them hold the anti-empirical belief that the economy is  a fixed pie and that one person can’t climb the economic ladder unless another person falls a few rungs.

There’s no doubt that the fixed-pie myth is an obstacle to sound thinking, but I’m wondering whether an even bigger problem is the pervasive belief on the left that there are easy shortcuts to prosperity.

Keynesian fiscal policy, for instance, is based on the notion that more growth is just a simple question of having the government spend more money.

And Keynesian monetary policy is based on a similarly simplistic assumption that more growth is generated by having central banks create more money.

To be sure, both policies may seem to work in the short run since people suddenly perceive that they have more money. But perceptions and reality may be different, particularly if the short-run boost in the economy is an illusory bubble.

And that’s why I’m not a big fan of QE-type policies designed to “stimulate” growth with artificially low interest rates.

As I explain in this brief FBN interview, any short-run gain is offset by long-run pain.

And I’m not the only one who has a jaundiced view.

The Wall Street Journal also is not happy with the Federal Reserve, opining that the real economy has stagnated as financial assets have been propped up by easy money.

…the Fed has only itself to blame for its economic and political predicament. …One lesson here is that the Fed’s great monetary experiment since the recession ended in 2009 looks increasingly like a failure. Recall the Fed’s theory that quantitative easing (bond buying) and near-zero interest rates would lift financial assets, which in turn would lift the real economy. …But while stocks have soared, as have speculative assets like junk bonds and commercial real estate, the real economy hasn’t. This remains the worst economic recovery by far since World War II…the economic expectations of Fed Chairs Ben Bernanke and Janet Yellen have been consistently wrong. …the Fed now finds itself caught between a slowing global economy and its promise to begin normalizing rates this year. …One result has been to increase economic uncertainty and market volatility.

Another result is that easy-money policies give politicians an excuse to avoid the real reforms that would boost long-run growth.

I definitely think that’s been a problem in Europe. Politicians keep waiting for magical results from the European Central Bank when the real obstacle to prosperity is a stifling burden of taxation, spending, and regulation.

The bottom line is that politicians all over the world are exacerbating bad fiscal and regulatory policy with bad monetary policy.

To augment this analysis, here’s a video from the Fraser Institute about the insight of Friedrich Hayek, who warned that government intervention, particularly via monetary policy, caused booms and busts by distorting market signals.

Needless to say, last decade’s financial crisis is a case study showing the accuracy of Hayek’s Austrian-school analysis.

But politicians never seem to learn. Or maybe they just don’t care. They focus on the short run (i.e., the next election) and it always feels good when the bubble is expanding.

And when the government-created bubble bursts, they can simply blame greed, or rich people, or find some other scapegoat (and then repeat the same mistakes as soon as the dust settles).

P.S. For a more detailed look at Austrian economics, check out this lecture. And Austrian-school scholars also have the best analysis of the Great Depression.

P.P.S. And for a more conventional critique of easy-money policies, here are some highlights from a speech by a member of the Bank of England’s Monetary Policy Committee.

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