Topic: Finance, Banking & Monetary Policy

Yellen and the Fed

The Senate Banking Committee just voted 14 to 8 to confirm Janet Yellen’s nomination to be the new Chair of the Federal Reserve. She will likely go on to be confirmed by the full Senate.

Much of the coverage has focused on Yellen as a person, when the real story is on the Fed as an institution. Sometimes individuals have profound influence on Fed policy, such as Paul Volcker  in the late 1970s and 1980s. Over time, however, the institutional structure of the central bank and the incentives facing policymakers matter more.

The Federal Reserve famously has a dual mandate of promoting maximum employment and price stability. The Federal Open Market Committee, which sets monetary policy, has great discretion in weighting the two policy goals. As a practical matter, the vast majority of the time, full employment receives the greater weight. That is because the Fed is subject to similar pressures as are the members of Congress to which the Fed must report. In the short run, voters want to see more job creation. That is especially true today. The United States is experiencing weak growth with anemic job creation.

Never mind that the Fed is not capable of stimulating job creation, at least not in a sustained way over time. It has a jobs mandate and has created expectations that it can stimulate job growth with monetary policy. The Fed became an inflation-fighter under Volcker only when high inflation produced strong political currents to fight inflation even at the cost of recession and job creation.

The Federal Reserve claims political independence, but it has been so only comparatively rarely. Even Volcker could make tough decisions only because he was supported by President Carter, who appointed him, and President Reagan, who reappointed him. Conventionally defined inflation is low now, so the Fed under any likely Chair would continue its program of monetary stimulus. Perhaps Yellen is personally inclined to continue it longer than might some other candidates. But all possible Fed chiefs’ would face the same pressures to “do something” to enhance job growth, even if its policy tools are not effective.

The prolonged period of low interest rates has made the Fed the enabler of the federal government’s fiscal deficits. Low interest rates have kept down the government’s borrowing costs, at least compared to what they would have been under “normal” interest rates of 3-4 percent.

Congress and the president have been spared a fiscal crisis, and thus repeatedly punted on fiscal reform. They are likely to continue doing so until rising interest rates precipitate a crisis. How long that can be postponed remains an open question.

Venezuela’s House of Cards

The story of the Venezuelan economy and its troubled currency, the bolivar, can be summed up with the following phrase: “From bad to worse”—over and over again. Yes, the ever deteriorating situation in Venezuela has taken yet another turn for the worse.

In a panicked, misguided response to the country’s economic woes, Venezuelan president Nicolas Maduro has requested emergency powers over the economy. And the Maduro government recently announced plans to institute a new exchange rate for tourists in an attempt to quash arbitrage-driven currency smuggling.

These measures will likely prove too little, too late for the Venezuelan economy and its troubled currency, the bolivar. Indeed, the country’s economy has been in decline since Hugo Chavez imposed his unique brand of socialism on Venezuela.

For years, Venezuela has sustained a massive social spending program, combined with costly price and labor controls, as well as an aggressive annual foreign aid strategy. This fiscal house of cards has been kept afloat—barely—by oil revenues.

But as the price tag of the Chavez/Maduro regime has grown, the country has dipped more and more into the coffers of its state-owned oil company, PDVSA, and (increasingly) the country’s central bank.

Since Chavez’s death, this house of cards has begun to collapse, and the black market exchange rate between the bolivar (VEF) and the U.S. dollar (USD) tells the tale. Since Chavez’s death on March 5, 2013, the bolivar has lost 62.36% of its value on the black market, as shown in the chart below the jump.

The Black Budget, a Sense of Magnitudes

On October 28th, I wrote a blog post, “The NSA’s Rent Is Too Damn High,” in which I looked at the $52.6 billion price tag for America’s spook infrastructure – the so-called “black budget.” When allocated across every American taxpayer, this staggering sum comes out to $574 per taxpayer, per year.

But, there are other edifying ways of gaining perspective on such a whopping amount of money. Doing so is important. Indeed, according to John Maynard Keynes’ biographer, Lord Skidelsky, Keynes believed that a good economist must always have “a sense of magnitudes.”

We can get a sense of magnitudes by looking at this year’s black budget as a portion of the major sources of the federal government’s revenues. The table below tells that tale:

Source of Federal Revenue 2012 Amount $ Billion Black Budget $ Billion Black Budget as % of Revenue Source
Individual Income Taxes $1,132.21 $52.60 4.6%
Corporate Income Taxes $242.29 $52.60 21.7%
Social Insurance Taxes $845.31 $52.60 6.2%
Excise Taxes $79.06 $52.60 66.5%
Estate and Gift Taxes $13.97 $52.60 376.4%
Customs Duties $30.31 $52.60 173.6%
Miscellaneous Receipts $107.01 $52.60 49.2%
Deficit (Borrowing) $1,086.96 $52.60 4.8%
     Source: Congressional Budget Office

This Month at Cato Unbound: The Federal Reserve at 100

We have now had 100 years of central banking. So what do we have to show for it? Has the Federal Reserve been worth it? If not, what should we do? 

That’s the topic of this month’s Cato Unbound. Our panel will present a variety of viewpoints, starting with Cato Senior Fellow Gerald P. O’Driscoll, Jr., who argues that a central bank is unnecessary in a classical regime of commodity money and free banking. Central banks are only needed, he argues, when governments want to spend beyond their means. He recommends returning to fiscal discipline and then to commodity money, under which a central bank will be unnecessary.

Opinions do differ on these questions, of course, and we will also hear from George Mason University Professor Lawrence H. White, Bentley University Professor Scott Sumner and former Cleveland Federal Reserve President Jerry L. Jordan. Readers are invited to submit comments and to follow us on Twitter and Facebook for regular updates and discussion.

Syrian Pound Soars, Iran’s Single Digit Inflation, and Other Troubled Currencies Project Updates

Syria: On September 27th, the United Nations Security Council unanimously adopted a resolution outlining the details of the turn over and dismantlement of Syria’s chemical weapons. Syria’s president, Bashar al-Assad, has stated that his government will abide by last week’s UN resolution calling for the country’s chemical weapons to be destroyed. 

It appears that this news was well received by the people of Syria. The black-market exchange rate for the Syrian pound (SYP) has dropped from 206 per U.S. dollar on September 25th to 168 on September 30th. That’s a whopping 22.6% appreciation in the pound against the dollar. Currently, the implied annual inflation rate in Syria sits at 133 percent, down from a rate of 185 percent on September 25th.

Iran: Since President Rouhani took office, Iranian expectations about the nation’s economy have turned positive. Over the past month we have seen a significant decrease in the volatility of the Iranian rial on the black market. This trend of stability has continued into this week, as President Rouhani’s trip to the UN has raised hopes of constructive cooperation with the West. In consequence, the rial has remained virtually unchanged on the black market, moving from 30,500 per U.S. dollar on September 25th to 30,200 on September 30th. The implied inflation rate in Iran as of September 30th stands at 8%, down from 23% on September 25th.

Venezuela: While the crises in the Middle East are easing, the troubles in Venezuela are far from over. The black market exchange rate for the Venezuelan bolivar has fallen from 44.03 per U.S. dollar on September 24th to 40.92 on September 30th. This represents an appreciation of 7.6% over the last week.  The implied annual inflation rate as of September 30th sits at 255%, down from a local high of 292% on September 17th. The ConocoPhillips dispute, a massive blackout, and worsening shortages caused by price controls have ravaged the Venezuelans’ confidence in the bolivar over the month of September.

Although the bolivar has rebounded modestly in recent weeks, this simply indicates that the economic outlook in Venezuela is only slightly less miserable than it was in mid-September. The economy is still on a slippery slope and economic expectations continue to be weighed down by the fragile political atmosphere, worsening shortages, and the ever-present specter of political violence. An inflation rate of 255% is nothing to celebrate.

Argentina: The black market exchange rate for the Argentine peso has held steady at around 9.5 per U.S. dollar since September 25th, with a 9.55 exchange rate on September 30th. That represents a 2.9% decrease in the value of the currency from the September 22nd rate of 9.27. The implied annual inflation rate as of September 30th sits at 54%, a decrease from the rate of 49% on September 22nd.

Egypt: The black market rate for the Egyptian pound has held steady at around 7.1 per U.S. dollar since September 25th, roughly the same level as the official exchange rate. This indicates that, for the time being, the military has brought some semblance of stability to the Egyptian economy. As of September 30th, the black market exchange rate was 7.12. The implied annual inflation rate as of September 30th sits at 19%.

For up-to-date information on these countries and their troubled currencies, see the Troubled Currencies Project.

Burrowing In at the Bank — And Your Business Next?

John Cochrane, who is an adjunct scholar at Cato as well as a professor at the University of Chicago Booth School of Business, had a nice post on the evolving nature of modern regulation earlier this month. He starts by quoting a Wall Street Journal account:

Your No. 1 client is the government,” John J. Mack, Morgan Stanley’s chairman and chief executive from 2005 to 2009, told current CEO James Gorman in a recent phone call. Mr. Gorman, who was visiting Washington that day, agreed…

….regulators prowl the office floor looking for land mines, and Mr. Gorman phones Washington before making major decisions…

About 50 full-time government regulators are now stationed at Morgan Stanley. There were none before 2008, when it was regulated as a brokerage firm instead of a bank.

Cochrane adds that this is “a useful anecdote to remind people what ‘regulation’ means.” People often imagine, he says, that it means something like enacting a knowable, impartial equivalent of a speed limit and enforcing it by putting more cops on the road.

No, we put 50 cops in your car. And how long can this possibly go on before the cops start asking where you’re going and why? How long can 50 regulators sit in the bank approving every decision, before “you know, you haven’t made any green energy loans in a long time” starts coming up? But contrariwise, how long before those 50 regulators come to the view that Morgan Stanley’s survival and prosperity is their job? 50 full-time government employees calling the shots on every deal at a supposedly private bank is a good picture to keep in mind of what “regulation” means.

And it isn’t just banking. On-site government inspectors are becoming more common in other lines of business, especially when a company has copped a deal to some earlier charge of regulatory violations – and few big companies have not been hit with charges of that sort. Notre Dame law professor Veronica Root explains what happens next:

…the corporation and the government often enter into an agreement stating that the corporation will retain a “monitor.” … A monitor, unlike the probation officer, is not solely charged with ensuring that the corporation complies with a previously determined set of requirements. Instead, a corporate compliance monitor is responsible for (i) investigating the extent of the wrongdoing already detected and reported to the government, (ii) discovering the cause of the corporation’s compliance failure, and (iii) analyzing the corporation’s business needs against the appropriate legal and regulatory requirements. A monitor then provides recommendations to the corporation and the government meant to assist the corporation in its efforts to improve its legal and regulatory compliance — the monitor engages in legal counseling.

Something to keep in mind next time you wonder why government officials and the leadership of big business so often seem to be working in harness, on issues where you might expect them to oppose each other. 

The Stock Market’s Embarrassing Fall after the Fed Reneged on the Taper

Unlike nearly everyone else, I have argued that the Fed’s latest round of “quantitative easing” is not why stock prices went up until recently, and that “tapering” Fed bond purchases would have had only a negligible effect on long-term interest rates.   

This was a testable hypothesis. If I was wrong, the Fed’s unexpected decision to back away from its previously-expected tapering of bond purchases would have been greeted by a significant, sustained rally in stock and bond prices. That didn’t happen. Instead, stocks fell for at least five days in a row and bond yields barely budged until stocks swooned (triggering a modest flight toward safe havens).

Before the Federal Reserve’s “surprise” at 2 p.m. on Wednesday September 18, nearly every financial reporter was confident the yield on 10-year Treasuries had increased to 2.86 percent from 1.66 percent in early May, simply because Fed officials hinted in May that they might begin to slow the pace of bond-buying by September. If that story had been true, we should have expected bond yields to retrace most of their rise as soon as the Fed removed that fear of the taper. Instead, the 10-year bond yield ended the week of the Fed announcement at 2.75 percent – no lower than the average yield in August (2.74) and merely a trivial 11 basis points lower  than the day before the Fed’s surprise.

Financial analysts and reporters were likewise certain the stock market had been terrified about the possible taper before September 18. If that was true, stocks should have soared for days or weeks on the supposedly terrific news that a taper was off the table. On the contrary, U.S. stocks were rising briskly for many days before the Fed meeting, but have since fallen persistently. A few hours of speculative stock gains on Wednesday the 18th were more than erased by Friday the 20th and stocks kept falling the following Monday, Tuesday and Wednesday.

Reporters and analysts who claimed stocks had been shored up by quantitative easing were logically obligated to expect a stock boom from the Fed’s message of no change. When stocks instead moved in the wrong direction, baffled reporters tried to blame their bad forecasts on mysterious “uncertainties” about the taper although there is obviously less uncertainty now than before.

Anyone who bases investment decisions on trendy theories that fail to predict what actually happens is either a poor journalist or a poor investor who pays undue attention to poor journalists. The market’s thumbs down vote on the Fed’s gutless decision to stick with quantitative easing provides added evidence that QE never helped stocks or the economy, and that ending such an obviously unsustainable policy will one day be welcomed as the good news that it really will be.