Topic: Finance, Banking & Monetary Policy

The States Have No Business Creating Their Own Retirement Accounts

People have lots of ways to save for retirement. Most employers offer some sort of retirement plan, of course, and people whose employers don’t can set up their own retirement account and get the same tax benefits, albeit without any employer contribution.  Low-income workers at a job without a benefit plan can now participate in Treasury’s new MyRA program, which creates a retirement account for the worker and provides a match for their contributions.

And Social Security, which totals to 15.3% of the first $118,500 of a worker’s income, constitutes a big chunk of most people’s retirement income.

Interest On Reserves, Part I

In my last post regarding Ben Bernanke’s memoir, I took Bernanke’s Fed to task for electing to sterilize its pre-AIG emergency lending, thereby making sure that, while it was rescuing a small number of troubled firms, it was also reducing the liquid reserves available to others. It was doing this, moreover, at a time when increasingly worrisome economic conditions were giving rise to exceptional liquidity demands. The predictable result was an overall shortage of liquidity, which manifested itself in a collapse of bank lending and spending.

I now turn to an even more mind-bogglingly wrongheaded step taken by Bernanke’s Fed in the course of the financial crisis: it’s decision to pay interest on banks’ excess reserves.

Venezuela v. Reality

Over a month ago — when Venezuelan’s were still living under the heel of Nicolás Maduro’s United Socialist party — Ilya Shapiro and I had a very interesting meeting with the folks behind DolarToday.  As the Wikipedia article concerning it explains, DolarToday  “is an American [nota bene] website that focuses on Latin American politics and finance.  The company is more known for being an exchange rate reference to the Venezuelan bolívar, a currency which is not freely convertible.”

My reason for attending the meeting was obvious enough: Venezuela has recently been suffering from the world’s highest inflation rate, making the Banco Central de Venezuela, Venezuela’s government-owned central bank, the current poster-child for government abuse of fiat money.  Ilya, on the other hand, was there because, besides being a senior fellow in Constitutional Studies at Cato and editor-in-chief of the Cato Supreme Court Review, he’s a lawyer.

You see, the Banco Central de Venezuela decided to sue DolarToday for “destabilizing” Venezuela’s currency.  That is, it claimed that the website, far from merely reporting the bolívar’s deterioration, was to blame for that deterioration and also for Venezuela’s general economic decline.

But hold on: doesn’t Wikipedia call DolarToday an “American” website?  It does indeed, and quite correctly.  The site is both Delaware-based and owned by U.S. citizens, who started it back in 2010.  But that hasn’t stopped the Venezuelan authorities from trying to shut it down, by filing their suit in Delaware’s U.S. District Court.

Lunch with Richard Leakey

The first issue of the Financial Time’s FTWeekend in December 2015 featured its regular “Lunch with the FT.” Richard Leakey was Clive Cookson’s luncheon guest, and Cookson’s account was appropriately titled “From Fossils to Film Stars.” Yes, Leakey, an accomplished paleontologist and son of Louis and Mary Leakey, has, like his parents, made many headline-grabbing fossil finds. He has also rubbed elbows with plenty of film stars. Just last month, Angelina Jolie and Leakey were in London, where they discussed plans for a movie in which Brad Pitt will portray Leakey.

At 70 years of age, Leakey is still going strong. Among other things, he is busy building the Turkana Basin Institute, which he founded, into a world-class research center on the site in northern Kenya where the Leakeys made many notable discoveries, including an almost complete 1.6 million-year-old skeleton known as Turkana Boy. But that’s not all Leakey is up to. Recently, he was appointed by President Uhuru Kenyatta to chair the Kenya Wildlife Service, which Leakey founded and served as director-general from 1989-1994.

In addition to paleontology, Leakey has a passion for wildlife conservation. I learned of this during my first lunch with him in the spring of 1972. It was then that the anthropologist Neville Dyson-Hudson, an expert on East African pastoral peoples, and I broke bread with Leakey at the Johns Hopkins Faculty Club in Baltimore. I anticipated plenty of paleontology and anthropology, but those weren’t on the menu. The conversation quickly turned to the topic that most interested Leakey, and as it turns out, the reason why my former colleague Dyson-Hudson had invited me to lunch in the first place: the economics of natural resources.

Leakey had a vision of land use and wildlife resources in East Africa. His observation was that the East African savannahs were, in large part, common property resources. In addition, Leakey noted that the wildlife that roamed over these vast savannahs were fugitive common property resources. He concluded that, unless property rights could be established, both the savannahs and wildlife would eventually be destroyed. For him, this would be a great tragedy not only for the wildlife, but also the indigenous peoples living off the lands in East Africa.

The Fed Acts

The Federal Reserve is set to act this week to raise short-term interest rates.  There are a number of technical and policy questions raised by this long-anticipated decision.  The Fed conventionally raises short-term interest rates by selling short-term Treasury obligations.  It no longer owns any short-term Treasuries to sell.

Based on prior statements, the Fed is expected to increase the interest rate on reserves held by commercial banks at Federal Reserve banks.  The Fed is operating in uncharted waters.  It is not clear how increasing interest on reserves will affect other short-term interest rates.  Further, the Fed is already paying commercial banks over $6 billion in interest payments annually.  That amounts to a fiscal transfer from taxpayers to bankers.  Raising rates will only increase that transfer.  As we approach a presidential election year, that is likely to become grist for political mills.

The Fed could also raise the interest rate on reverse repurchase agreements at a facility at the New York Fed.  The Fed is effectively borrowing money from financial institutions like money market funds.  It functions as a subsidy to those institutions, as the Federal Reserve System has no business or policy reason for borrowing money.  Once again, I would anticipate political questioning of such a move.

Free-market economists are in a policy conundrum.  Most have long advocated higher interest rates.  But the facilities through which that policy will now be effected have questionable validity.  Some of the same economists advocating higher short-term rates have also been critical of the Fed’s payment of interest on reserves.  Those economists must now ask for more of something they wanted none of.  Operational considerations are confounding substantive policy.

All of the above is a consequence of the Fed’s having implemented extraordinary monetary policy.  That included shedding all liquid, short-term Treasury obligations in favor of loading up on risky and illiquid, long-term debt obligations.  Critics argued the Fed would rue the day it did that.  Now that day has arrived.

[Cross-posted from]

Quantitative Easing: A Requiem

When the Federal Open Market Committee (FOMC) meets in Washington next week, its members are widely expected to vote to raise interest rates for the first time since June 2006.  By doing so, they will move towards monetary policy normalization, after more than seven years of near-zero interest rates, and a vast expansion of the central bank’s balance sheet.

But how did monetary policy become so abnormal in the first place?  Were the Fed’s unconventional monetary policies a success?  And how smoothly will implementation of the Fed’s so-called “exit strategy” go?  These are among the questions addressed by Dan Thornton, a former vice president of the Federal Reserve Bank of St. Louis, in “Requiem for QE,” the latest Policy Analysis from Cato’s Center for Monetary and Financial Alternatives.

Sterilization, Fed Style

At the risk of belaboring the obvious, I feel compelled to begin this second installment of my response to Ben Bernanke’s memoirs with an observation — a platitude, if you like — concerning the proper role of emergency central-bank lending in a generally free economy.

The observation is simply that emergency lending, far from being an end in itself, is but one of many possible means by which a central bank might achieve the ultimate end of avoiding general reductions in lending and spending that might otherwise result in more general business failures — that is, in a recession or depression. For so long as the overall flow of spending remains stable, it must be the case, as a matter of simple logic, that aggregate business receipts do not fall remarkably short of aggregate outlays, and that the flagging incomes of particular firms are matched by the net revenues of others.

From this banal observation two others follow. The first is that central bank emergency lending can be justified only to the extent that it succeeds in keeping overall spending stable. The second is that a central bank that allows the overall volume of spending to collapse has blown it, no matter how much emergency lending it undertakes. Indeed, to the extent that a central bank engages in emergency lending while failing to preserve aggregate spending, it may be guilty of compounding the damage attributable to the collapse of spending itself with that attributable to a misallocation of scarce resources in favor of irresponsibly-managed firms. Thanks to moral hazard, the extent of such misallocation, instead of being proportionate to the actual volume of emergency lending, is augmented by the expectation that such lending will continue to be resorted to in the future.