April 27, 2018 4:17PM

Must Rising Oil Prices Compel the Fed to Tighten More?

As crude oil prices recently approached $68 a barrel, a Wall Street Journal writer concluded that “inflation fears got an added jolt this week as oil prices rose to a three-year high.”

Two other Wall Street Journal writers added that “If crude continues to move higher, it could begin to stifle economic growth.”  They suggest that “higher consumer prices for gasoline and other energy products act like a tax, while pushing inflation higher and increasing pressure on the Federal Reserve to raise interest rates more aggressively.” 

Such anxieties about $70 oil are obviously overwrought. Crude prices were usually above $100 from March 2011 to September 2014, yet nobody was then fretting about inflation fears forcing the Fed to raise the fed funds rate.   

But this does raise two very important issues: First, the importance of soaring oil prices in the recession of 2008-2009.  Second, the way the Federal Reserve has overreacted to surging oil prices by pushing up interest rates before and during oil-shock recessions and (in 2008) leaning against their fall after the recession was well under way.

In May 2009, economist James Hamilton of U.C. San Diego testified before the Joint Economic Committee.  He noted that, “Big increases in the price of oil that were associated with events such as the 1973-74 embargo by the Organization of Arab Petroleum Exporting Countries, the Iranian Revolution in 1978, the Iran-Iraq War in 1980, and the First Persian Gulf War in 1990 were each followed by global economic recessions. The price of oil doubled between June 2007 and June 2008, a bigger price increase than in any of those four earlier episodes.”  

Like every postwar recession except 1960, the “Great Recession” of 2008-09 was preceded by a spike in the price of crude oil.  West Texas crude soared from $54 at the start of 2007 to $145 by mid-July 2018.  Yet U.S. reporters and economists still write as though the Great Recession had nothing to do with a global energy shock but was instead a “financial crisis” that began with the collapse of an investment bank (Lehman Brothers) on September 15, 2008.  This is a stubborn myth.

In reality, the inability of unemployed homeowners to pay their mortgage bills, and the failure of investments tied to those mortgages, were secondary complications of a global energy shock which cut industrial production in Canada and Europe in 2017 before that happened in the U.S.  By the end of 2008, the contraction of real GDP “was twice as deep in Germany and Britain  [as it was in the U.S.] and much worse in Japan and Sweden.”

Because energy is a key part of the cost of doing business, higher energy costs made production and distribution less profitable and thereby shrunk the global economy’s supply.  Yet even as late as June 2008, as crude prices soared above $140, The New York Times and Washington Post were hysterical about illusory inflation – not recession. 

Did the Fed also mistake a temporary oil price spike for a sustained rise in the overall trend of inflation?  I believe it did that in 2008 and even more obviously in prior incidents of a sudden surge in oil prices.

The big oil price spikes (and recessions) between 1973 and 1980 that Hamilton mentioned were clearly matched by huge spikes in the Fed-controlled interest rate on federal funds.  Oil prices and the fed funds rate were also rising before the 1991 and 2001 recessions. When crude rose from $34 to $74 from May 2004 to June 2006, the fed funds rate rose from 1 percent to 5.25 percent.  Once recessions were well underway the Fed always began to bring interest rates back down, but always (including 2008) too slowly.

On January 2, 2008, The Financial Times published my article, “Why I am Not Using the-R-Word This Time.”   Citing James Hamilton, I wrote that “if the emphasis on oil prices in Prof Hamilton’s 1983 study is correct, the US economy is likely to slip into recession because of higher energy costs alone, regardless of what the Fed does. If Mr. Bernanke’s 1997 study is right, timely reductions in the Fed funds rate should avert such a recession.”  Once he became Fed chairman, unfortunately, Bernanke did not aggressively cut the funds rate in a timely manner – but instead tried hard to prop rates up.  As Cato’s George Selgin documented, “Between December 2007 and September 2008, the Fed sold over $300 billion in Treasury securities, withdrawing a like amount of reserves from the banking system, or just enough to make up for reserves it created through its emergency lending,” One result was to keep the fed funds rate above 2 percent until September when oil prices finally fell.  In October the Fed also began paying interest on bank reserves (above 1 percent until mid-December) to discourage bank lending.  

Although an oil price of around $70 is only half as high as the peak in 2008, and lower than it was just a few years ago, we do have a lot of experience with sudden increases in oil prices that always ended in recession.  And we have a lot of experience with the Fed acting as though they were not focused on “core” inflation at all (i.e., excluding energy) but were unduly influenced by the misleading and ephemeral impact of oil price gyrations on headline inflation numbers.  

So, the Wall Street Journal's recent warning that “If crude continues to move higher, it could begin to stifle economic growth” would be likely only if crude moved a lot higher.  And the warning that a higher oil price must put “pressure on the Federal Reserve to raise interest rates more aggressively” would be likely only if the Fed has still not learned anything from one of its biggest and most frequently repeated mistakes.

September 19, 2017 9:13AM

Poll: Public Distrusts Wall Street Regulators as Much as Wall Street, Say Gov’t Regulators Are Ineffective, Biased, and Selfish

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The new Cato Institute 2017 Financial Regulation national survey of 2,000 U.S. adults released today finds that Americans distrust government financial regulators as much as they distrust Wall Street. Nearly half (48%) have “hardly any confidence” in either. 

Click here for full survey report

Americans have a love-hate relationship with regulators. Most believe regulators are ineffective, selfish, and biased:

  • 74% of Americans believe regulations often fail to have their intended effect.
  • 75% believe government financial regulators care more about their own jobs and ambitions than about the well-being of Americans.
  • 80% think regulators allow political biases to impact their judgment.

But most also believe regulation can serve some important functions:

  • 59% believe regulations, at least in the past, have produced positive benefits.
  • 56% say regulations can help make businesses more responsive to people’s needs.

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However, Americans do not think that regulators help banks make better business decisions (74%) or better decisions about how much risk to take (68%). Instead, Americans want regulators to focus on preventing banks and financial institutions from committing fraud (65%) and ensuring banks and financial institutions fulfill their obligations to customers (56%).

Americans Are Wary of Wall Street, But Believe It Is Essential

Nearly a decade after the 2008 financial crisis, Americans remain wary of Wall Street.

  • 77% believe bankers would harm consumers if they thought they could make a lot of money doing so and get away with it.
  • 64% think Wall Street bankers “get paid huge amounts of money” for “essentially tricking people.”
  • Nearly half (49%) of Americans worry that corruption in the industry is “widespread” rather than limited to a few institutions.

At the same time, however, most Americans believe Wall Street serves an essential function in our economy.

  • 64% believe Wall Street is “essential” because it provides the money businesses need to create jobs and develop new products.
  • 59% believe Wall Street and financial institutions are important for helping develop life-saving technologies in medicine.
  • 53% believe Wall Street is important for helping develop safety equipment in cars.

Few Americans Want “More” Financial Regulations—They Want the Right Kinds of Regulations, Properly Enforced

Polls routinely find that a plurality or majority of Americans want more oversight of Wall Street banks and financial institutions. This survey is no different. A plurality (41%) of Americans think more oversight of the financial industry is needed. However, only 18% think the problem with federal oversight of the banking industry is that there are “too few” rules on Wall Street. Instead, 63% say the government either fails to “properly enforce existing rules” (40%) or enacts the “wrong kinds” of regulations on big banks (23%).

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Most Are Skeptical Dodd-Frank Will Prevent Future Financial Crises



Will Dodd-Frank financial reforms work? Nearly three-fourths (72%) of Americans don’t believe that new regulations on Wall Street and the financial industry passed since the 2008 financial crisis will make future crises less likely. Just over a quarter (26%) believe such regulations will make future financial downturns less likely.

Americans Oppose Too Big to Fail

Americans reject the idea that some banks are so important to the U.S. economy that they should receive taxpayer dollars when facing bankruptcy. Instead, 65% say that “any bank and financial institution” should be allowed to fail if it can no longer meet its obligations. A third (32%), however, believe that some banks are too important to the U.S. financial system to be allowed to fail.

  • Part of the reason most oppose the “Too Big to Fail” model may be that 60% believe that banks would make better financial decisions if they were convinced government would let them go out of business.
  • Clinton voters (41%) are about twice as likely as Trump voters (20%) to believe some banks are too integral to the U.S. economy to fail. Libertarians are most opposed (81%) to bailing out banks. 

Despite Distrust of Wall Street, Americans Like Their Own Banks and Financial Institutions

  • 90% are satisfied with their personal bank; 76% believe their bank has given them good information about the rates and risks associated with their account.
  • 87% are satisfied with their credit card issuer; 81% believe their credit card issuer has given them good information about the rates, fees, and risks associated with their card.
  • 83% are satisfied with their mortgage lender.
  • Of those who have used payday or installment lenders in the past year, 63% believe the lender gave them good information about the fees and risks associated with the loan.[1]

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Americans Want Regulators to Prioritize Fraud Protection, Ensure Banks Keep Promises

Financial regulators have a variety of tasks and goals. The public, however, believes that regulation should serve two primary functions: to protect consumers from fraud (65%) and to ensure banks fulfill obligations to their account holders (56%). Other initiatives such as restricting access to risky financial products (13%) is a priority among far fewer people.

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Democrats and Republicans Want a Bipartisan Commission to Run CFPB, Divided on CFPB Independence

 

  • Most support changing the structure of the Consumer Financial Protection Bureau (CFPB), a new federal agency created by Dodd-Frank in 2011. Nearly two-thirds (63%) of Americans think the CFPB should be run by a bipartisan commission of Democrats and Republicans, rather than by a single director. Support is post-partisan with 67% of Democrats and 64% of Republicans in favor of a bipartisan commission leading the agency.
  • A majority (54%) of Americans think that Congress should not set the CFPB’s budget and should only have limited oversight of the agency. Given that only 7% of the country has confidence in Congress, these numbers are not surprising. A majority of Democrats (58%) support keeping the CFPB independent while a plurality of Republicans (50%) say Congress should closely oversee the new agency and set its budget.
  • Few Americans (26%) believe the CFPB has achieved its mission to make the terms and conditions of credit cards and financial products easier to understand. Instead, 71% say that since the CFPB was created in 2011 credit card terms and conditions have not become easier to understand—including 54% who believe they have stayed the same and 17% who think they have become less clear.

Americans as Likely to Say CEOs, NFL Football and NBA Basketball Players Are Overpaid, But Most Oppose Government Regulating Pay

Americans are about equally likely to think that CEOs (73%) and professional athletes like NBA players (74%) and NFL players (72%) are paid “too much.” Yet, the public doesn’t think the government ought to regulate the salaries of either corporate executives (53%) or professional athletes like NBA players (69%). Nonetheless, there is more support for regulating CEO pay (43%) than NBA salaries (28%).

Notably, compared to CEOs (73%) and NBA players (74%), far fewer believe that major tech company entrepreneurs are overpaid (51%). 

Democrats support (56%) government regulating the salaries of CEOs but oppose regulating salaries of NBA players (66%) and famous actors (69%). In contrast, about 7 in 10 Republicans oppose government regulating the salaries of all three professions, even though they are more likely than Democrats to believe NBA players (60% vs. 47%) and famous actors (59% vs. 37%) are overpaid. 

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Most Support Risk-Based Pricing for Loans, Say Low Credit Scores are Due to Irresponsibility

Nearly three-fourths of Americans (74%) say they’d be “unwilling” to pay more for their home mortgage, car loan, or student loan to help those with low credit scores access these loans.

Americans may be unwilling to pay more to help those with low credit scores in part because a majority (58%) believe low credit scores are primarily due to irresponsibility, rather than circumstances beyond a person’s control (41%).

  • Partisans sharply disagree about the cause of a low credit score. Most Democrats (57%) say low scores are primarily the result of “circumstances beyond [one’s] control” while 74% of Republicans and 63% of independents say “irresponsibility” is the primary cause.

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Americans are Unsure if Banks Charging Some People Higher Interest Rates is Justified or Predatory

A slim majority (52%) believe banks and financial institutions need to charge some people higher interest rates for loans and credit cards if those individuals present higher credit risks. Another 46% believe banks charge some people higher rates for loans in order to take advantage of those with few other options.

  • Partisans disagree about why banks charge people different rates. A majority (56%) of Democrats believe lenders charge some people higher interest rates because they are predatory and take advantage of the vulnerable. In contrast, two-thirds (67%) of Republicans believe banks need to do this to compensate themselves for some borrowers’ greater credit risk.

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Most Oppose Accredited Investor Standard, Say Law Should Not Restrict Investment Options Based on Wealth

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Due to current law, some investments are deemed too risky for the common investor and are only available to those with one million dollars in assets or who make $200,000 or more a year. However, a majority of Americans (58%) say the law should not restrict what people are allowed to invest in based on their wealth or income—even if the investments in question are risky. Thirty-nine percent (39%) think the law should restrict access to certain investments deemed risky.

  • Strong liberals are unique in their support (57%) of government restricting access to risky investments based on a person’s wealth. Support drops to 45% among moderate liberals and to a third among conservatives. 

Most Support Helping Low-Income Families Own Homes Unless Policies Escalate Mortgage Defaults

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Nearly two-thirds (64%) of the public support government policies intended to make it easier for low-income families to obtain a mortgage. However, a majority (66%) would oppose such policies if they resulted in more mortgage defaults and home foreclosures.

43% of Americans Would Pay for $500 Unexpected Expense with Savings

Less than half (43%) of Americans say they would pay for an unexpected $500 expense using money from savings or checking. The remainder would put the expense on a credit card (23%), ask family and friends for money (8%), sell something (7%), borrow the money from a bank or payday lender (5%), or simply not be able to pay it (12%).[2]

Most Say Bad Financial Decisionmaking Due to Lack of Financial Education and Self-Discipline 

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The public says the top three reasons consumers make bad financial decisions include lacking financial education (70%), lacking self-discipline (60%), and facing financial hardship (54%). Less than half say that consumers being “misled or tricked” (43%), taken advantage of (42%), or incapable (30%) are primary causes.

  • Both Democrats (72%) and Republicans (72%) agree that a lack of financial education is key.
  • Republicans (70%) are nearly 20 points more likely than Democrats (51%) to say that a lack of self-discipline is a primary reason for unwise decisionmaking.
  • Democrats are roughly 20 points more likely than Republicans to say that poor financial decisionmaking is due to external circumstances such as financial hardship (66% vs. 45%), being tricked (52% vs. 32%), or being taken advantage of (52% vs. 30%).

Most Say Government Should Allow Individuals to Make Their Own Financial Decisions—Even If They Make the Wrong Ones

When it comes to promoting and managing consumers’ financial health, most believe (58%) that individuals “should be allowed to make their own decisions even if they make the wrong ones.” However, 4 in 10 say that sometimes government regulators “need to write laws that prevent people from making bad decisions.” 

  • A majority of Democrats (57%) believe that sometimes regulators need to write laws that protect people from making bad decisions
  • Majorities of Republicans (73%) and independents (69%) don’t think government should restrict people’s financial choices to protect them.

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Few Americans Know a Lot about the Federal Reserve; Among Those Informed, the Fed Polarizes Partisans 

  • Only 20% of Americans say they have heard of the Federal Reserve and understand what it does very well. Half (50%) have heard of the Fed but don’t understand everything it does; 22% have heard of the Fed but don’t know what it does while 6% have never heard of it.
  • Tea Partiers (67%), libertarians (57%) and conservatives (50%) are about three times as likely as liberals (19%) to say the Fed has “too much power.”
  • Pluralities of libertarians (50%) and strong conservatives (50%) believe the Fed helped cause the 2008 financial crisis. In contrast, a plurality of liberals (43%) believe the Fed cut the crisis short.
  • Among those with an opinion, 68% of Democrats want Federal Reserve officials to primarily determine interest rates in the economy. Conversely, 74% of Republicans want the free-market system to do this. 

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Click here for full poll results and methodological information

Sign up here to receive forthcoming Cato Institute survey reports

The Cato Institute 2017 Financial Regulation Survey was designed and conducted by the Cato Institute in collaboration with YouGov. YouGov collected responses online May 24-31, 2017 from a national sample of 2,000 Americans 18 years of age and older. Restrictions are put in place to ensure that only the people selected and contacted by YouGov are allowed to participate. The margin of error for the survey is +/- 2.17 percentage points at the 95% level of confidence.




[1] Asked of 4% of respondents who have used payday or installment lenders in the past 12 months, N=71.



[2] One percent (1%) say they would find some other way to pay the unexpected expense.

 

March 1, 2016 1:10PM

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?

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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.

December 11, 2015 10:19AM

Quantitative Easing: A Requiem

By Tom Clougherty

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.

Thornton begins with an account of the Fed’s deliberations and actions during the early stages of the financial crisis.  What’s particularly striking, looking back, is how the Fed resisted letting its balance sheet grow, or otherwise departing from its conventional, funds-rate targeting procedure, until the Great Recession was well underway.

In fact, from August 2007, when BNP Paribas suspended redemption of three of its investment funds, to September 2008, when Lehman Brothers filed for bankruptcy, the Fed loaned banks and others more than $300 billion.  But these loans were sterilized—meaning that the Fed sold an equal amount of government securities.  As a result, the Fed’s balance sheet didn’t grow, and neither did total bank reserves or the monetary base.  For over a year, in other words, the Fed reacted to a growing liquidity crisis not by taking steps to boost credit in general, but rather by reallocating the existing supply of credit towards particular, troubled firms — a move George Selgin examined (and criticized) in detail in a recent post on this blog.

The Fed’s approach flew in the face of widely-acclaimed research presented by Milton Friedman and Anna Schwartz in their A Monetary History of the United States.  As Thornton points out, Friedman and Schwartz “connected substantial reductions in the nominal quantity of money and credit to correspondingly large declines in economic activity, and declared it the Fed’s duty to act quickly to prevent such reductions by expanding the monetary base.”  In 2007–08, however, no such action was forthcoming, and the crisis continued to intensify.

The sad part is that then-Fed chairman Ben Bernanke knew all this.  Back in 2002, he concluded a speech in honor of Milton Friedman’s 90th birthday by declaring: “I would like to say to Milton and Anna:  Regarding the Great Depression.  You’re right.  We did it.  We’re very sorry.  But thanks to you, we won’t do it again.”  And yet, as Thornton makes clear, “it” — failing to expand the balance sheet in order to prevent a collapse of credit — is “precisely what the Fed did in the months leading up to Lehman Brothers’ failure.”

Eventually, the Fed was forced to change tack.  Once Lehman Brothers collapsed, it found itself lending and buying assets on a scale that couldn’t possibly be sterilized via correspondingly large asset sales.  The Fed’s balance sheet grew, bank reserves began to pile up, and the federal funds rate dropped well below the FOMC’s target.  Unofficially, and almost by accident, quantitative easing (QE) began.

Quantitative easing was put on a formal footing in March 2009, when the FOMC announced the combined purchase of $750 billion of mortgage-backed securities and $300 billion of Treasuries.  From the very beginning, however, it was clear that the Fed was not belatedly adopting a Friedmanite approach.  The stated purpose of their asset purchases was not to boost the monetary base — that was just a side effect.  Instead, the Fed’s goal was to manipulate the yields on certain long-term assets, in the hope that this would spill over into broader markets, and the economy as a whole.

How was it meant to work?  Well, as Thornton points out, the rationale was “vague and highly uncertain,” and developed over time as QE was put into effect.  But the general idea was twofold.

First, by forcing down yields on the long-term assets it was purchasing, the Fed hoped other investors would be induced to substitute those assets for similar, but somewhat higher-yielding alternatives.  In turn, that shift in demand would push down yields on the alternative assets, encouraging investors who held them to rebalance their portfolios as well.  As this ripple effect spread through the financial markets, equilibrium interest rates would fall.

Second, the Fed hoped that QE announcements would signal to markets that monetary policy was going to be “persistently more accommodative” — Ben Bernanke’s words — than previously thought.  This would lower investor expectations for the path of short-term interest rates, and in so doing put additional downward pressure on long-term interest rates.

In short, then, the Fed expected QE to boost the economy through the interest rate channel of monetary policy: lower interest rates would boost equity prices and weaken the dollar; lower borrowing costs, higher wealth, and greater international competitiveness would drive spending, investment, and exports, and stimulate an ailing economy.

So did QE actually work in this way?  Thornton assesses these claims in detail (see, in particular, pp. 12–22 of his analysis), and finds little — either in economic theory or in empirical evidence — to support them.

For one thing, as large as the Fed’s asset purchases were relative to previous open market operations, they were modest compared to financial markets as a whole.  It is therefore “difficult to believe,” as Thornton puts it, “that the distributional effects of the FOMC’s quantitative easing policy could have had a significant effect on either relative yields or the level of the entire interest rate structure.”  What’s more, the event-study literature on QE announcements does not offer any convincing evidence of their effectiveness, once you account for the effect of other, simultaneous announcements (Fed statements typically contain a variety of news capable of influencing bond yields).

The claim that QE announcements changed expectations for the path of short-term interest rates is similarly hard to substantiate, not least because event studies only show the immediate impact of such announcements — and for QE to reduce long-term interest rates via this signaling channel, its effect on expectations must be persistent.  It is telling, moreover, that the Fed’s QE announcements did not even produce a consensus among FOMC participants about the expected path of the federal funds rate.  That being the case, it is hard to see how those same announcements could have had a significant impact on market expectations — especially when it is well-established that interest rates are, in Thornton’s words, “essentially unknowable beyond horizons of a few months.”

Of course, that QE did not work as the Fed hoped does not mean it had no effect at all.  As Thornton points out, “a monetary policy directed at keeping interest rates on low-risk securities near zero … is sure to cause people to seek higher yields by purchasing more risky assets.”  Thornton suggests that pension funds, in particular, have been forced to hold riskier portfolios to generate the returns necessary to meet their obligations.  As well as raising concerns about future financial crises, this distortion of investor behavior has had distributional effects: wealthy investors, who are better able to assume more risk, have benefited from booming equity prices, whereas as less well-off pensioners — who have good reason to be risk averse — have had to settle for miserly returns on their fixed-income portfolios.

What QE hasn’t done, however, is enhance the aggregate supply of credit to the market.  This is hardly surprising, given that the Fed began paying interest on bank reserves in October 2008 — a move designed to encourage banks to build up excess reserves, instead of increasing lending.  Indeed, when it came up at FOMC meetings, Ben Bernanke, Janet Yellen, and others expressly rejected the idea that QE would stimulate the economy by boosting bank lending.  Still, when you couple this absence of increased credit with the lack of evidence that QE worked the way the Fed thought it would, you would be forgiven for wondering whether QE had any significant impact on output and employment at all.

What now?  The Fed’s large-scale asset purchases are over, and the FOMC’s interest rate target looks set to gradually rise.  But the Fed’s “exit strategy” remains a work in progress.  Interest on reserves (IOR), for example, may yet prove a troublesome way of raising the federal funds rate.  As Thornton points out, “An IOR of 3 percent … would see the Fed paying nearly $80 billion a year in interest to the commercial banking sector — something that is unlikely to prove popular in Congress or among the general public.”

Meanwhile, the Fed’s preferred alternative, overnight reverse repurchase agreements, would have to be rolled over continuously to have any effect on the size of the Fed’s balance sheet.  A better approach, according to Thornton, would be to “begin the process of policy normalization by selling long-term securities slowly … If things go well, sales could subsequently be accelerated.”  But the Fed seems reluctant to consider outright asset sales at all.  This suggests that the bloated central bank balance sheet that QE created could be with us for some time to come — whether or not the FOMC votes next week to begin the process of policy normalization.

Yet the real legacy of QE may come in how the FOMC reacts to the next crisis.  One concern is that the Fed seems to have lost “all confidence in the ability of markets to heal themselves,” and now assumes that “only monetary or fiscal policy actions” can “restore the economy’s health.”  Another worry is mission creep: “If the Fed can support the mortgage and commercial papers markets … why shouldn’t it support the market for student loans — or any other market for that matter?”  It’s a dispiriting prospect, but both of these observations suggest an increasingly hyperactive monetary authority going forward.

Ultimately, says Thornton, we should prepare ourselves for more of the same: given the opportunity, “the Fed will continue to distort markets until, by some as-yet-unknown magic, those markets return to normal.”  One suspects that such magic may be a long time coming.

[Cross-posted from Alt-M.org]

June 23, 2015 4:39PM

Are State Regulators A Source of Systemic Risk?

The Dodd-Frank Act creates the Financial Stability Oversight Council (FSOC).  One of the primary responsibilities of the FSOC is to designate non-banks as "systemically important" and hence requiring of additional oversight by the Federal Reserve.  Setting aside the Fed's at best mixed record on prudential regulation, the intention is that additional scrutiny will minimize any adverse impacts on the economy from the failure of a large non-bank.  The requirements and procedures of FSOC have been relatively vague.  We have, however, gained some insight into the process since MetLife has chosen to contest FSOC's designation of MetLife as systemically important.

One of the benefits of MetLife's resistance has been to shed additional light on some of the rationales used by FSOC.  While FSOC pretty much throws everything in the kitchen sink at MetLife, one of the more interesting (and bizarre) claims is that MetLife is a risk to financial stability because of the potential behavior of state insurance regulators.  After raising the specter of a run by policy-holders (yes, the old bank-run spin), FSOC then worries that state insurance regulators might actually use their authorities to "impose stays on policyholder withdrawals and surrenders."  You'd think this would be a good thing, but no FSOC worries that "Surrenders and policy loan rates could increase if MetLife’s policyholders feared that stays were likely to be imposed either by MetLife’s insurance company subsidiaries or by their state insurance regulators."  So yes, FSOC is serious here.  The ability of state regulators to stop "runs" could be the very cause of those runs, and hence MetLife must be regulated by the Federal Reserve.

Such an argument would be bad enough on its face, but it also ignores that the "orderly liquidation authority" of Dodd-Frank allows the FDIC, when resolving a non-bank, to also impose stays.  The FDIC can also void payments made up to 90 days before the beginning of a receivership.  So under FSOC's logic, the fact that (federal or state) governments can reduce the confidence of counter-parties in a company is grounds for additional regulation of said company.  This kind of spin basically allows FSOC, and by extension the Fed, to pretty much regulate anyone they want, if the government is the very source of the potential instability. 

February 23, 2015 3:12PM

Does Fed Leverage and Asset Maturity Matter?

Debate over whether to subject the Federal Reserve to a policy audit has occasionally focused on the size and composition of the Fed's balance sheet. While I don't see this issue as central to the merits of an audit, it has given rise to a considerable amount of smug posturing. Let's step beyond the posturing and give these questions some of the attention they deserve.

First the facts. The Fed's balance sheet has ballooned over the last few years to about $4.5 trillion. And yes, the Fed discloses such. No argument there. The Fed, like most central banks, has traditionally conducted its open-market operations in the "short end" of the market. The various rounds of quantitative easing have changed that. For instance the vast majority of its holdings of Fannie & Freddie mortgage-backed securities ($1.7 trillion) have an average maturity of well over 10 years. Similarly the Fed's stock of treasuries have long maturities, about a fourth of those holdings in excess of 10 years.

Now the leverage question. We all get that the Fed cannot go "bankrupt" like Lehman. But that's because "bankrupt" is a legal condition and one from which the Fed has been exempted. Just like Fannie and Freddie cannot go "bankrupt" (they are considered legally outside the bankruptcy code). The eminent economist historian Barry Eichengreen tells us the Fed's leverage doesn't matter as "the central bank can simply ask the government to replenish its capital, much like when a government covers the losses of its national post office." Some of us would say that's a problem not a solution, just like it is with the Post Office.

Others would suggest the Fed's leverage doesn't matter because "the Fed creates money". Again that misses the point. Any losses could be covered by printing money, but isn't that inflationary?  And that, of course, is just another form of taxation. So it seems Senator Paul's primary point, that the Fed's balance sheet exposes the taxpayer to some risk has actually been supported, not discredited, by these supposed rebuttals.

Let's get to another issue, the maturity of the Fed's assets. There's a good reason central banks generally stay in the short end of the market. It avoids taking on any interest rate risk.  When rates go up, bond values fall. Yes the Fed can avoid recognizing those losses by simply not selling those assets. But that creates problems of its own. If we do see inflation, normally the Fed would sell assets to drain liquidity from the market. But would the Fed be willing to sell assets at a loss? At the very least there would be some reluctance. And yes they could cover those losses by printing money, but that's hardly helpful if the Fed finds itself in a situation of rising prices.

The point here is that the Fed's balance sheet does raise tough questions about its exit strategy.  Perhaps the economy will remain soft for years and the Fed can exit gracefully.  Perhaps not.  I raised this possibility before Congress a year ago.  I don't know anyone with a crystal ball on these issues.  But one thing is certain, this is a debate we should be having.  Its the "nothing to see here, move along" crowd that poses the true risk to our economy.

February 17, 2015 3:26PM

Fact Checking the Fed on “Audit the Fed”

With the introduction of bills in both the House (H.R. 24) and Senate (S.264) allowing for a GAO audit of the Federal Reserve's monetary policy, officials at both the Board and regional Fed banks have launched an attack on these efforts.  While we should all welcome this debate, it should be one based on facts.  Unfortunately some Fed officials have made a number of statements that could at best be called misleading. 

For instance Fed Governor Jerome Powell recently claimed "Audit the Fed also risks inserting the Congress directly into monetary policy decisionmaking".  I've read and re-read every word of these bills and have yet to find such.  H.R. 24/S.264 provide for no role at all for Congress to insert itself into monetary policy, other than Congress' existing powers.  I would urge Governor Powell to point us to which particular part of the bill he is referring to, as I cannot find it.

Perhaps Governor Powell is worried that an audit would allow Congress to regularly "harass" the Fed.  David Wessel states this fear as "Fed officials worry...that aggressive members of Congress unhappy with a Fed interest-rate decision could dispatch the GAO repeatedly to investigate, essentially using the GAO as a way to pressure the Fed to change its policies."  Richmond Fed President Jeff Lacker has described this as "high frequency harassment".  Such comments, however, display a fair amount of ignorance as to how GAO operates.  As someone who has handled GAO requests for the Senate Banking Committee, I can say there's nothing "high frequency" about it.  Even H.R. 24/S.264 contemplates a 90 day turnaround after an audit is completed.  Neither Congress nor GAO is currently constituted in such a manner for any of this to happen at "high frequency".

Several Fed policy-makers point out that the Fed is already "audited".  Of course that's besides the point since the bills are not about financial audits, but rather policy audits. 

Perhaps most bizarre is that Powell and Dallas Fed President Richard Fisher have ventured into the world of second-guessing the motives of the authors' of H.R.24 and S.264.  Generally I believe it bad form to attribute motives to people who haven't actually expressed those motives.  And of course public policy should be judged on its impact, not speculative motives.  For instance I'm not sure what to say to Fisher's implication that Audit the Fed is being driven by antisemitism.  Or his implication that its authors want to distract from Congress' failings on the budgetary front, especially since those behind H.R.24/S.264 have generally been at the forefront of trying to address our budgetary imbalances.  It isn't an "either or".  In fact given the Fed's dominance of the treasury market, the Fed has been an enabler of the reckless fiscal policy which Fisher laments. 

Of course there are other more subjective claims presented as facts.  Powell first presents the Fed's crisis actions as "very much in keeping with the traditional role of the Fed" but then later admits "the Fed's actions after the onset of the financial crisis were unprecedented in scale and scope".  So which is it? Keeping within tradition or unprecedented in scale and scope?  Unsurprisingly the Fed presents all its actions as correct and beyond question.  The fact that these actions are far from obvious "successes" further illustrates the need for an audit.

I welcome officials from the Fed to a broader discussion on the potential merits and costs of Audit the Fed.  That said, try first reading the bills in question and keeping to the facts.