Tag Archives: central banks

Should we have a hard dollar, backed by gold?

Summary: We’ll hear much from Republicans during Campaign 2016 about the glories of a gold-backed currency. Today’s post debunks that with history from 19th Century Britain, when both men and money were hard.   {1st of 2 posts today}

“Accursed thirst for gold! what dost thou not compel mortals to do?”
— Virgil’s Æneid (29-19 BC).

Gold coins

Belief in the superiority of a gold-based currency is a core element of their faux economics. They believe it provides a fixed foundation for the economy and prevents boom-bust cycles. It ignores not just modern economic theory but also two centuries of western history.

First, fixed is not always good. It’s usually better for interest rates and currency values to change rather than shocks flow through to national income and employment. To use a bad medical analogy, why don’t we all get pacemakers to stabilize our heart rate? Would a fixed pulse improve our health, especially during sex and other forms of vigorous exercise?

Second, a gold-based currency does not prevent financial bubbles or minimize boom-bust cycles. These occurred under the one of the most solid monetary systems, 19th C Britain, predating fiat currencies (and another of the Right’s bugaboos, fractional reserve banking; see Wikipedia for details). These cycles are an inherent aspect of free-market economies. They can occur even without credit, and can be reproduced in classroom exercises.

James Narron and Don Morgan at Fed of New York tell the story of one of the first great modern bubbles, it’s bursting, and the Bank of England’s successful response: “Crisis Chronicles: Railway Mania, the Hungry Forties, and the Commercial Crisis of 1847“. It’s a fascinating story and relevant to us today. Excerpt…

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Let’s ignore another warning from the BIS. Do we enjoy paying for burst bubbles?

Summary: As one market after another drifts off into bubble valuations, a few institutions warn of the consequences. As usual (we’ve done this so many times), we ignore them — our passivity and ignorance earning our role as the deep pockets paying for the resulting damage. This post looks at a few of the warnings from the venerable Bank of International Settlements — the “world’s oldest international financial organization”, the central banks’ central bank.

For more about this see How we’ve become accustomed to bubbles bursting the economy, instead of fighting them.

This is post #3,000, with over 5.5 million page views since opening in Nov 2007.


The BIS gives us yet another warning about the increasing prevalence of asset price bubbles in our financial system: “Asset Bubbles: Re-thinking Policy for the Age of Asset Management“. A excerpt appears at the end of this post, but the message should be obvious to all by now. Earlier analysis by the BIS pointed to the dangers of rising leverage (traditional buying on margin plus and endless array of derivatives) coupled with expansive monetary policy — and (although they can hardly mention this) little regulation of banks).  This report (carefully labeled as not representing BIS views) warns of structural factors encouraging speculative buying (e.g., herding and trend-following by investment managers). After all, it’s not their money.

It’s an enlightening report, typical of the BIS. It carefully avoids more than gentle questions about central banks’ role in this, especially the “put” (price guarantee) they’ve created on prices of financial assets. On the other hand, let’s be grateful for any warnings we get. Although we’ll ignore them, as we did during the housing and tech bubbles. FAILure to learn is an expensive vice.

Previous warnings from the BIS

These are unusually blunt warnings from an institution such as the BIS. Of course they know better than most that nobody is listening because the game must continue while there is money to be made by the financial industry. It’s the public’s role afterwards to politely write checks for the damage.

William R. White (former CIS chief economist)

“I see speculative bubbles like in 2007.” (Interview, 11 April 2014)

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Why the libertarian rich & their bankers love price controls – on money.

Summary: Marx believed that the inherent contradictions in capitalism would bring about its downfall. Events since the crash have revealed contradictions between the values and actions of the 1% and their bankers. But they’ve successfully managed these contradictions. That’s the operational genius of the pseudo-philosophy called libertarianism.  {1st of 2 posts today.}

The price system works so well, so efficiently, that we are not aware of it most of the time. We never realize how well it functions until it is prevented from functioning, and even then we seldom recognize the source of the trouble.

… Prices perform 3 functions in organizing economic activity: first, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product — the distribution of income. These three functions are closely interrelated.

Milton Friedman, from Chapter 1 “The Power of the Market” in “Free to Choose” (1980)

Libertarian: more freedom, less government

Libertarians Ascendant

{political movements} “are a kind of ghost town into which anyone can move and declare himself sheriff”.
— Saul Bellow, quoted by Allan Bloom in “Closing of the American Mind”

Investors — whether professional or just rich (the top 1% own 42% of non-home financial assets; the top 10% own most of the rest) tend to some form of libertarianism. Typical of libertarians, their opinions vary — but with one firm tenet: markets should be free. After all, that’s the source of their wealth and income. Their allegiance to free markets has limits, however, when it comes to what they love most: money.

Since the crash the Federal Reserve has intervened in the US economy with actions unprecedented in their size and duration. They pegged the short-term interest rates to zero, and bought 20% ($2.5 Trillion) of the public Federal Debt plus $1.7 trillion of home mortgages. They have controlled the most important prices in an economy: the price of money, expressed through the prices of financial assets. (e.g., see this Citi survey of global credit managers).

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Today began the next phase of the great monetary experiment, as reality plays a trump card.

Summary: Today began the next phase of the great monetary experiment, the collision of Central Bankers’ bold promises with reality.  History suggests skepticism about the odds of CB’s success (e.g., see the many unbreakable currency pegs and unions which broke). Today the Swiss National Bank folded its cards. Here we discuss the significance of this to them and to us.  This is part one; see tomorrow’s post for the conclusion.

Wizard of Oz

Bow before our Monetary Wizards!

Since the crash, governments of the western nations have conducted the greatest economic experiment ever, with us as the subjects of unprecedented monetary and fiscal stimulus. We have had massive deficits, long periods of zero interest rates (for some now, negative interest rates), and repeated rounds of quantitative easing (in various forms). So far the results have varied by nation from good to great. But as with any experiment, preliminary results often don’t match the final tally. Today we began the next phase.  First here’s some background.

Switzerland’s bold monetary experiment.

“The minimum exchange rate remains for the foreseeable future the key monetary policy instrument. We’re prepared to buy unlimited amounts of foreign currencies and, if necessary, take further measures …. We will continue to defend the minimum exchange rate with utmost determination …”

— Thomas Jordan, President of the Swiss National Bank, 23 September 2014 — Speech in defense of the 1.20 peg to the Euro set in September 2011.

To keep their exports competitive in September 2011 the Swiss National Bank (SNB) set a minimum exchange rate (a ceiling to the Swiss Franc vs the Euro). In September 2014 President Jordan promised to print unlimited Swiss Francs to defend this level. Some were skeptics, such as the people at Grant’s Interest Rate Observer, 19 September 2014 — Excerpt:

Like a celebrity in flight from the paparazzi, the Swiss Confederation demands protection from its pesky admirers. … The {Swiss franc} is still, for many, the monetary bolt-hole of choice. To the Swiss, whose exports generate 54% of Switzerland’s GDP, it’s a kind of popularity they can live without — indeed, they insist, must live without. So the SNB prints francs.  It drew a monetary line in the sand three years ago: The franc shall not rally through the 1.20-to-the-euro mark, the authorities commanded in September 2011. To enforce this dictum, they bought euros with newly created francs (the cost of production of the home currency being essentially zero).

What to do with the rising euro mountain? Invest it, of course. CFA fashion, the central bankers are diversifying across asset classes and currencies. Among these asset classes are equities, and among these currencies is the dollar. As of June 30, the Swiss managers held $27 billion in 2,533 different U.S. stocks, according to the bank’s latest 13-F report …

Here’s a metaphysical head scratcher. The Europeans conjure euros, which the Swiss buy with their newly materialized francs. The managers exchange the euros for dollars (also produced by taps on a keyboard) and with that scrip buy ownership interests in real businesses. The equities are genuine. The money, legally and practically speaking, is itself real.. But what is its substance? We mean, how is it different from air?

… In these stupendous interventions, the SNB is hardly unique. Nor is it alone as it attempts to undo, through administrative means, the distortions it creates through monetary policy. New “macro- prudential” directives have tightened standards for home-loan amortization schedules, minimum down payments, affordability, bank capital ratios, etc.

Grant’s recommendation:

{W}e venture that the SNB will sooner or later be forced to permit the franc to appreciate and thus to enrich the holders of low-priced, three-year call options on the Swiss/euro exchange rate. It’s a long shot, to be sure — the options are cheap for a reason — but we judge that the prospective reward is worth the obvious risk.

Four months later their recommendation paid off — big. Bloomberg describes the fireworks:

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Japan leads us into a new future, taking the next step in the great monetary experiment

Summary: A first step to understanding comes from appreciating the wonders before us. Recognition of extraordinary events that lie before us. Not unique events (those are seldom seen), but event of unusual magnitude. Old Faithful, not the usual steam kettle on the stove. Today we look at one such, one of the greatest experiments ever: sustain large-scale monetary stimulus.

In “Forbidden Planet” a great distant civilization — far away, long ago — built a planetary-scale machine to grant their every wish. It didn’t end well for them, but they deserve high marks for the boldness and scale of the project. Today economists are attempting something less ambitious, but still bold beyond any precedents.

ATLAS experiment

In the basement of the Federal Reserve


Size of central bank balance sheets for the major nations (2014 IMF estimate):

  • China: $4.8 trillion, 49% of GDP
  • Japan: $2.0 trillion, 39% of GDP
  • UK: $0.7 trillion, 25% of GDP
  • US: $4.2 trillion, 24% of GDP
  • EU: $3.0 trillion, 23% of GDP

These are mind-blowing numbers, become familiar to us in the five years since the crash.

Combined with artificially low interest rates (near-zero in all of the above but China), the major nations have sought to restore growth using extreme and unconventional monetary policy measures. The first phase — first aid to stabilize their financial systems during the crash (2008-09) were a success. The results since then, using monetary policy for extended treatment, remain unknown until the experiment concludes and monetary policy returns to normal.

As with any bold experiment, economists will learn much from the results. If successful, it will be a new world. Economic policy of the 21st century will look nothing like that of the post-WW2 era, any more than the dark nighttime cities of Victorian London resemble its brightly lite 21st century version. Future downturns — and even more so with future crashes — will be met with tsunamis of newly printed cash. Perhaps we’ve built a monetary savior, like the discovery of antibiotics.

We’ll know when the experiment is concluded. So far the results are cloudy; we’ll have to ask again later.

Japan leads the way

Haruhiko Kuroda

Haruhiko Kuroda

Japan is the cutting edge of this experiment, going boldly to where no nation has gone before. While other nations look to slow the monetary engines, they’re revving them up even more.

Bank of Japan Governor Haruhiko Kuroda said there were “no limits” to what the central bank can do if it saw the need to adjust monetary policy in the future, signaling readiness to expand stimulus further if risks threatened its price target {2% inflation}. … He also said it was “not as if there weren’t any steps left” for the BOJ to take if it were to ease again, countering views held by some market participants that having delivered a massive stimulus last year, the BOJ had no tools left to deploy.

— Interview on 13 March with Japan’s Jiji news agency, as reported by Reuters

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The easy way to understand unconventional monetary policy

Summary:  It’s difficult to describe the magnitude of the monetary policy experiments now running around the world, most especially in China, USA, and Japan. At the end are links to a dozen posts attempting to do so with words and numbers. Today we do it with pictures.

Money world


The monetary stimulus programs running around the world are in effect leaps into the future, leaps of a scale never before attempted, leaps beyond theory. Should they work the world will changed, for these tools — massive quantitative easing and extended periods of zero interest rates (ZIRP) — will be used again. And again.

How can I show you the fantastic nature of these experiments? How they move far beyond what’s been considered possible — even prudent — in the past. How their success would create a new world? And, most difficult, how the programs of each nation differ in scope and daring?

Let’s use picture to show this, as metaphors.

First, the below picture shows America’s monetary policy: five years of ZIRP and three rounds of quantitative easing — designed by the four hundred economists of the Federal Reserve System, using unconventional means to press conventional theory beyond its limits — to rekindle the power of the American economy.


Fusion and Dr Octavius


Second, we see Japan. They’ve had zero or near-zero interest rates since February 1999 (with intermissions), and several rounds of quantitative easing since March 2001 — attempts to re-ignite their economy since it flamed out in 1998. The latest is the three arrows of Abenomics (often described in different ways), announced by Prime Minister Shinzo Abe in December 2012.

  1. More fiscal stimulus, increasing the government’s deficit by 2% of GDP (to 13%).
  2. More monetary stimulus: doubling the money supply in 2 years to create 2% inflation.
  3. Structural reform — broad, deep, powerful (so far missing in action).

Abenomics is the desperate action of leaders who have tried everything in the playbook, and now tap unimaginable energies to unleash arcane regenerative forces that can revitalize Japan’s economy. They go beyond theory, a leap combining faith and science.

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A Fed Governor speaks honestly to us about the costs and risks of our monetary policy

Summary: Fed officials see as tools their ability to manage our confidence and expectations. This means a constant policy of exaggeration and distortion in their speeches, as truth and plain-speaking are secondary considerations. But there are exceptions. Perhaps the most famous is Bernanke’s 2002 “the U.S. government has a technology called a printing press” speech. This week as another, an even more impressive and rare example of honesty by a high government official. He warns us that the extreme monetary policy of today has costs, and might prove difficult to unwind. Let’s pay attention to his words.

Note: We tend to get our news and insights through intermediaries, who inevitably filter and distort the content. On the FM website we try to avoid this, instead giving excerpts with links to the full text.  Governor Fisher — like the IPCC, and the famous leaders of our past — speaks to us, and needs no interpreters.

Magic Hat Money

Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes
With Reference to Peter Boockvar, the Book of Matthew, Sherlock Holmes, ‘The Wolf of Wall Street’ & Denis Healey

Richard Fisher, President of the Federal Reserve Bank of Dallas
Remarks before the National Association of Corporate Directors
14 January 2014

Excerpt #1:  Beer Goggles …

Two comments I recently read have been buzzing around my mind as I think about the many issues that will condition my actions as a voter.

The first was by Peter Boockvar, who is among the plethora of analysts offering different viewpoints that I regularly read to get a sense of how we are being viewed in the marketplace. Here is a rather pungent quote from a note he sent out on Jan. 2:

“… QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good …”

For those of you unfamiliar with the term “beer goggles,” the Urban Dictionary defines it as “the effect that alcohol … has in rendering a person who one would ordinarily regard as unattractive as … alluring.” This audience might substitute “wine” or “martini” or “margarita” for “beer” to make it more age-appropriate, but the effect is the same: Things often look better when one is under the influence of free-flowing liquidity. This is one reason why William McChesney Martin, the longest-serving Fed chairman in our institution’s 100-year history, famously said that the Fed’s job is to take away the punchbowl just as the party gets going. {1955 speech}

Peter Boockvar is Chief Market Analyst of The Lindsey Group (bio here). Here is an early statement of his “beer goggles” theory.

Excerpt #2: Free and Abundant Money Changes Perspective, the first explicit mention I’ve seen by a Fed official of QE’s possible ill effects.

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