Topic: Finance, Banking & Monetary Policy

Update on Gisele and the Dollar

Maybe Gisele Bundchen is not bearish on the dollar after all. CNBC is pouring cold water on reports suggesting that the Brazilian supermodel prefers euros:

Anne Nelson, Bundchen’s manager … tells us reports that Gisele wants to be paid in euros are “false.” Nelson’s take: “Some idiot in Brazil reported something just to make news.” Nelson points out that Gisele lives in New York City, and thus needs U.S. dollars for her big-city lifestyle. Of course, anyone who disagrees with Warren Buffett’s investment wisdom does so at their own risk. But we have to think Gisele gets enough U.S. dollars that she can absorb any potential weakness against the Euro.

But this is not just a story about the strength of the dollar. The CNBC story notes that she lives in New York City, which raises the issue of whether she is a resident of the US for tax purposes. This would be a major mistake since America probably has the world’s worst tax system for people with global income. Being a selfless person concerned about the plight of the over-taxed entrepreneur, I want Gisele to know that I am willing to counsel her on how best to protect her earnings from rapacious government, even if it requires many hours and late-night meetings.

Gisele, feel free to contact me at my dmitchell [at] cato [dot] org (Cato email address). I’m here for you in your time of need.

Supermodels and Monetary Policy

I’m not sure she qualifies as a leading economic indicator, but Gisele Bundchen’s demand to be paid in euros is the latest sign that the dollar may be losing its position as the world’s reserve currency. A supermodel’s currency choice may not be as important as the dollar’s slide against the euro, and it may not mean much compared to the rise in gold prices, but if these other factors aren’t convincing the Fed to protect the value of the dollar, maybe a visit from Gisele would do the trick. Bloomberg reports:

Gisele Bundchen wants to remain the world’s richest model and is insisting that she be paid in almost any currency but the U.S. dollar. …”Contracts starting now are more attractive in euros because we don’t know what will happen to the dollar,” Patricia Bundchen, the model’s twin sister and manager in Brazil, said in a telephone interview in September from Sao Paulo. She declined to discuss details of the arrangements last week, as did Anne Nelson, Bundchen’s agent in New York at IMG Models. …Wealthy clients at San Francisco-based Union Bank of California have doubled their deposits in foreign currencies to $60 million the past two months as a hedge against a decline, said Bradley Shairson, head of currency and derivatives at the bank. …That’s the same strategy as sovereign wealth funds run by the largest exporters and oil producers, including China, Singapore and Qatar, said Stephen Jen, head of currency research at New York-based Morgan Stanley. The funds may grow to $17.5 trillion by 2017 from $2.5 trillion now and shift more than $500 billion out of the dollar in the next three years in search of better returns, he said. “We’re all thinking about diversifying out of the dollar,” said Jen, who is based in London. “It’s a very logical thing.”

European Central Bank Mocks French Fiscal Policy

An amusing public fight is taking place, with Germany and the European Central Bank on one side and France on the other. I’m not sure whether this calls for a surrender joke or a wry reference to the Iran-Iraq war and how it would be nice for both sides to lose, but I will demonstrate uncharacteristic maturity by instead focusing on the policy implications.

The French, not surprisingly, are wrong. They have been badgering the European Central Bank to mimic the mistakes of America’s Federal Reserve by creating too much liquidity in order to artificially lower interest rates.

Germany is on the side of the Central Bank, which wisely has focused on maintaining the value of the currency (which helps explain why the dollar has been falling compared to the euro). As part of this spat, the head of the European Central Bank very publicly pointed out the wretched state of France’s bloated government budget. The EU Observer reports:

European Central Bank (ECB) chief Jean-Claude Trichet has said that France’s public finances are in “very great difficulty.” “In 2007, according to statistics from the European commission, France will be the country spending the most in public expenditure in relation to gross domestic product, not only within the eurozone but among the 27 members of the European Union”, Mr Trichet told Europe 1 radio on Sunday (23 September). On top of that, “the development of France’s public finances has on average been significantly worse than that of other European countries”, he added. …Mr Trichet’s comments also come as a reply to French president Nicolas Sarkozy, who has repeatedly criticised the ECB lately on a number of points, notably for not cutting interest rates. …Mr Trichet, who has also repeatedly stressed the need for the ECB to remain independent from any political pressure and has been riled by Mr Sarkozy’ comments, pointedly took Berlin as an example of a government which has managed to lower its public expenditure. Currently, Germany’s public spending is nine percentage points of GDP lower than that of France, which has to “adapt faster”, if it wants to benefit best from a global economy, Mr Trichet said.

Greenspan Condemns Profligate Republicans

The Wall Street Journal reports that the former Chairman of the Federal Reserve Board strongly criticizes President Bush and congressional Republicans for wasting so much money on ill-conceived government programs:

In a withering critique of his fellow Republicans, former Federal Reserve Chairman Alan Greenspan says in his memoir that the party to which he has belonged all his life deserved to lose power last year for forsaking its small-government principles. In “The Age of Turbulence: Adventures in a New World,” published by Penguin Press, Mr. Greenspan criticizes both congressional Republicans and President George W. Bush for abandoning fiscal discipline. …Mr. Greenspan, who calls himself a “lifelong libertarian Republican,” writes that he advised the White House to veto some bills to curb “out-of-control” spending while the Republicans controlled Congress. He says President Bush’s failure to do so “was a major mistake.” Republicans in Congress, he writes, “swapped principle for power. They ended up with neither. They deserved to lose.” …”Little value was placed on rigorous economic policy debate or the weighing of long-term consequences,” he writes.

Poole on Friedman’s Monetary Legacy

Like Andrew Coulson, I attended an event in honor of Milton Friedman’s birthday yesterday. This one was in Missouri, and it featured Bill Poole, who’s president of the Saint Louis Federal Reserve Bank and a frequent participant in Cato events on monetary policy. The event was sponsored by the University of Missouri and the Show-Me Institute. In his speech, he credited Friedman with making the case that changes in the money supply are a major factor in the business cycle. However, he noted that modern-day central bankers do not agree with Friedman’s contention that central banks should focus on limiting the growth of the money supply:

Everything Milton argued about money stock control is true, but the effect of inflation expectations on the practice of monetary policy itself was, I believe, a missing element in the analysis. The economy functions differently when inflation expectations are firmly anchored. If a central bank allows expectations to become unanchored, then interest-rate control becomes a dangerous and potentially destabilizing policy. But should the practice of monetary policy depend on how well inflation expectations are anchored? I do not recall Milton discussing this question, perhaps because he believed that the best way to maintain well-anchored expectations over time was for the central bank to commit to steady and low money growth under all circumstances.

How does a central bank anchor inflation expectations? One approach would be for the central bank to commit to low and steady money growth come what may. A problem with this approach is that it may not appear credible to the markets when financial instability and/or recession occurs. If a policy of steady money growth has exceptions, can the exceptions be defined in such a way to retain anchored inflation expectations?

A necessary and sufficient condition for anchoring is that the central bank act vigorously to resist inflation or deflation whenever it becomes evident and particularly when inflation expectations change, up or down, in an unwelcome way. If the central bank is willing to push as hard as it takes, regardless of short-run consequences to unemployment and especially to the bond and stock markets, then market participants will develop firm views on the likely rate of inflation in the future. The Fed must convince market participants who bet against it that they will regret their bets.

However, Poole concludes that “Although Milton did not prevail in his quest to have the Fed maintain a constant money-growth rate, he did prevail in his insistence that policy be apolitical and rely to the maximum possible extent on market judgments. He lost a battle but truly did win the war.”

Fed Chairman Explains Benefits of Free Trade, Warns against Protectionism

Federal Reserve Board Chairman Ben Bernanke delivered an important speech Tuesday on the benefits of free trade to our economy and workers. Speaking to an audience in Butte, Montana, Bernanke explained why trade raises our standard of living and backed up his economic logic with up-to-date evidence.

He acknowledged that some workers and companies lose out, at least temporarily, from more vigorous global competition, but he warned that protectionism would be the worst possible policy response.

As the Fed chairman told his audience:

Restricting trade by imposing tariffs, quotas, or other barriers is exactly the wrong thing to do. Such solutions might temporarily slow job loss in affected industries, but the benefits would be outweighed, typically many times over, by the costs, which would include higher prices for consumers and increased costs (and thus reduced competitiveness) for U.S. firms. Indeed, studies of the effects of protectionist policies almost invariably find that the costs to the rest of society far exceed the benefits to the protected industry. In the long run, economic isolationism and retreat from international competition would inexorably lead to lower productivity for U.S. firms and lower living standards for U.S. consumers.

Rather than closing U.S. markets, Bernanke wisely recommends “policies and programs aimed at easing the transition of displaced workers into new jobs and increasing the adaptability and skills of the labor force more generally.”

If you want to understand what free trade really means for Americans, I recommend the full text of his illuminating speech.