tag:blogger.com,1999:blog-34323687.post5129473562053797251..comments2024-03-19T03:05:57.184+00:00Comments on Macro Man: Does the Fed's dual mandate spell doom for the dollar?Macro Manhttp://www.blogger.com/profile/12324967552369915949noreply@blogger.comBlogger17125tag:blogger.com,1999:blog-34323687.post-32181545149151186572007-11-17T02:36:00.000+00:002007-11-17T02:36:00.000+00:00Arguably this is a case (as perhaps is your excell...<I>Arguably this is a case (as perhaps is your excellent post, MM) for a gold standard and a rejection of credit as money, to eliminate any lag and to limit the magnitude of the credit cycle.</I><BR/><BR/>With a gold standard, at least in the USA, there certainly was strong instabilities and cycles, because there was still fractional reserve banking. <BR/><BR/>The gold reserves were, let's say, 'level 0' assets in modern speak, but US dollars were created by individual banks depending on their banker's willingness to lend. (Quite literally, as there were physical currency notes printed and redeemed by individual banks and these had sub $1:$1 market values upon rumors of bank failures). <BR/><BR/>This meant that a change in attitude---fear replacing greed---resulted in sharp contraction of money supply. And without a counter cyclical central bank (and fiat money), and competitive market forces, the second part of the Wall Street rule ("If you do panic, make sure to panic first!") resulted in strong dynamical instability as well. <BR/><BR/>In practice, this meant that banks were confiscatory predators in downturns. The hard-nose strictness of the gold standard meant that the banks passed the consequences along to their clients, and hence many loans were callable on demand. <BR/><BR/>In a systemic credit crunch and given 19th century transportation and information realities, these poor sots had no refinancing alternatives and otherwise productive but long term assets like factories and farms were effectively expropriated-by-tail-fluctuation in a fully legal, open capitalist economy. <BR/><BR/>There were conspiracy theories, some of which are probably true, that bankers colluded to engineer these at various times to increase their wealth. They empirically appear to have been successful. In the real world, Mister Potter won. <BR/><BR/>The increase in population and economic growth was incompatible with the realities of gold mining.<BR/><BR/>And is still today, and we also we know how environmentally damaging and generally stupid an activity it is. <BR/><BR/>Fiat money is the worst possible form of money until you consider alternatives. <BR/><BR/>The history of 20th century shows that William Jennings Bryant was right about gold.<BR/><BR/>The previous poster was also right about time-delay differential equations (!): as a very rough rule, chaos tends to appear very easily (wide range of parameter settings) in such systems versus ordinary differential equations. <BR/><BR/>A gold standard might reduce the time-delay but it sure puts the instantaneous coefficient into instability faster, during downturns.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-37977275512621006132007-11-16T13:48:00.000+00:002007-11-16T13:48:00.000+00:00Thanks for the interesting and thoughtful posts, g...Thanks for the interesting and thoughtful posts, guys. I suppose where I come down on the issue is the folloing list of thoughts:<BR/><BR/>1) The USD has been the predominant global reserve currency because of the unique financial standing, and the depth of asset markets it has produced, of the US economy in the postwar period.<BR/><BR/>2) This in turn has produced an artifically high demand for both dollars and dollar assets, which has tended to make both artificially strong.<BR/><BR/>3) The Fed has been directed to conduct monetary policy with a purely domestic focus; given the explicit growth aspct of the mandate, this has been inherently disadvantageous to non-resident holders of dollars.<BR/><BR/>4) However, in the absence of credible alternatives, foreign reserve accumulators have continue to plow money into dollars/peg to dollars, in spite of the fact that Fed policy has, for al intents and purposes, explicitly ignored their utility<BR/><BR/>5) As such, the dollar has enjoyed a sort of "foreign reserve seignorage", wherein US borrowing costs have been lower than they would have otherwise been given fundamentals and monetary policy<BR/><BR/>6) However, the emergence of the euro as a credible alternative has eroded that monetary seignorage that the US has enjoyed; this has been particularly acute aftr the launch of notes and coins in 2002 confirmed the euro as a 'real' currency.<BR/><BR/>7) That loss of seignorage has not yet impacted Fed policy, primarily because of the loss of seignorage has been RELATIVE, not ABSOLUTE. In other words, while the euro has gained enormous creidbility relative to the dollar, the sheer scale of FX reserve accumulation has meant that the US has continued to enjoy off-market interest rates.<BR/><BR/>8) Domestic inflation in the economies of mercantilists and oil producers means that they are icreasingly unwilling to pay that seignorage to the US. The final leg of any dollar crisis would presumably entail a large rise in long term interest rates/steepening of the curve as reserve accumulators go on a buyers strke that endures for more than two weeks.<BR/><BR/>And the ultimate outcome will likely force American hosueholds to alter their behaviour, increase savings rates, and drive smaler cars....just as the 1970's changed behaviour, for broadly similar reasons.Macro Manhttps://www.blogger.com/profile/12324967552369915949noreply@blogger.comtag:blogger.com,1999:blog-34323687.post-5765132837390450642007-11-16T01:47:00.000+00:002007-11-16T01:47:00.000+00:00In Louis XVI's France, a few economists (e.g. Turg...In Louis XVI's France, a few economists (e.g. Turgot), realizing that the state finances were on a crash course, argued that, in order to preserve at least part of the status quo, the nobility had to relinquish some of their privileges (specifically, their exemption from paying all taxes). Their stark advice fell into deaf years and the economists ended up quickly losing their jobs.<BR/><BR/>On the other hand, most of that time's economists, vying for the nobles' favor and appointments, reassured them that things were working the way they were supposed to, and that there was no need to part with any of the practices that had been established by history. Their soothing advice was welcome by the nobles who, by following it, in a few years had parted with their lands or their heads.<BR/><BR/>Today, a few economists realize that the US dollar status as the international trade and reserve currency is inherently precarious, arising as it does from its voluntary acceptance by foreigners:<BR/><BR/><BR/>"At present, Americans and non-Americans alike make and receive international payments in dollars because they have confidence that dollars will, relative to other transaction vehicles, retain their value well in future commercial transactions. It is hardly science fiction to imagine a tomorrow in which this is no longer the case."<BR/><BR/>Benn Steil, Director of International Economics at the Council on Foreign Relations, 2007, <BR/>http://www.foreignaffairs.org/20070501faessay86308/benn-steil/the-end-of-national-currency.html<BR/>and<BR/>http://www.cato.org/pubs/journal/cj27n2/cj27n2-10.pdf<BR/><BR/>"Falling US interest rates would make the control of inflation even more difficult within the emerging world, eventually increasing the temptation to "go it alone" and leave the dollar to its own destiny. Might this lead to a dollar collapse, a loss of US monetary credibility and the end of an economic pax Americana?<BR/><BR/>Perhaps this is a fairy-tale too far. ... The story unfolding ... may finish happily ever after. But it might, instead, end up like one of those novels from my namesake, a horrific mixture of weak growth, sticky inflation and, ultimately, a loss of confidence in the dollar's status as a reserve currency."<BR/><BR/>Stephen King, managing director of economics at HSBC, 2007 Oct 1st, <BR/>http://news.independent.co.uk/business/comment/article3015584.ece<BR/><BR/>What even fewer economists realize is the extent to which life-as-Americans-know-it depends on the US dollar keeping, at least in part, its current privileged status, and the consequences that the complete loss thereof can bring about.<BR/><BR/>I.e., if the US sticks to its post-Bretton Woods 1 position, and keeps focusing its monetary policy on avoiding internal recessions, regardless of the dollar's external value, countries with current-account surpluses that over the last decade have (out of their own folly) built up huge dollar reserves will be left with no choice but to realize (at long last) that their behavior is most unwise, and change it, at the very least, by stopping their dollar purchases and letting their currencies appreciate against the dollar. <BR/> <BR/>The problem comes if the ensuing fall in the dollar value triggers a chain reaction where dollar holders start to also sell it, the value falls further, and it ends up with the dollar being abandoned as the main international trade and reserve currency. The key point is: if the world's monetary system reaches a final equilibrium state where the dollar is just one more currency in a world of peer fiat currencies, where the only reason to hold it is to pay for exports from the ISSUING country, then the huge amount of dollars (and US-issued dollar-denominated debt) already circulating outside the US ensures that in that final state the equilibrium value of the dollar will be hugely lower than today's. And the impact on US life will be huge too. <BR/> <BR/>I explored this issue in a modest essay at <BR/>http://peaktimeviews.blogspot.com/2007/10/realistic-view-of-international.html <BR/><BR/>The alternative path would be for the US to adopt a monetary policy (and a consistent fiscal policy) geared to preserving the purchasing power of the USD for international transactions by checking the GLOBAL supply growth of the US dollar. Unpleasant recessions may come as a result, but the alternative could be much worse. <BR/> <BR/>Again, in the words of Steil: <BR/> <BR/>"This is the only sure way to keep the United States' foreign tailors, with their massive and growing holdings of dollar debt, feeling wealthy and secure. It is the market that made the dollar into global money -- and what the market giveth, the market can taketh away."Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-12856533194252142802007-11-15T23:13:00.000+00:002007-11-15T23:13:00.000+00:00As my previous comment have shown I am no economis...As my previous comment have shown I am no economist. However I do understand feedback and feedback systems pretty well.<BR/><BR/>With this in mind, you can imagine the Fed as being charged with providing stabilising feedback (in the form of short term rates) to regulate desired measures of economic activity (inflation, GDP growth). The Taylor rule is what we would call simple proportional feedback. The simplest feedback law there is, in fact.<BR/><BR/>The trouble begins with the measures such as PCE or political dissatisfaction. These are naturally and necessarily lagging the actual state of the economy (which is not directly observed by the measures). So we have a 'closed loop' system of economy and the fed providing the controlling feedback. A system with a time delay and proportional feedback, to summarise. Systems theory easily shows that such systems are not necessarily stable. If the Fed's response lags the right sort of length, and I think political factors encourage it to be backwards looking, the feedback actually becomes <I>destabilising</I>. In this case, the credit binge-and-busts are larger each time. I suspect this is happening.<BR/><BR/>Arguably this is a case (as perhaps is your excellent post, MM) for a gold standard and a rejection of credit as money, to eliminate any lag and to limit the magnitude of the credit cycle.<BR/><BR/>Alternatively, and more progressively, a less naive (to this non-economist's mind) feedback rule would be appropriate. Still, tricky job, being the Fed.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-41353521842259580852007-11-15T22:15:00.000+00:002007-11-15T22:15:00.000+00:00I am not re: USD so convinced they do not care abo...I am not re: USD so convinced they do not care about "their" economies. <BR/><BR/>I could be more easily convinced that they do not care now.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-23420785165402291782007-11-15T22:13:00.000+00:002007-11-15T22:13:00.000+00:00I think the dual mandate is understandable given t...I think the dual mandate is understandable given the history of the United States Bank(s) beforehand. It might be better to have a more independent central bank with a dual mandate rather than a solely inflation targeting bank that gets dismantled every few years.HoosierDaddyhttps://www.blogger.com/profile/06070310058834687381noreply@blogger.comtag:blogger.com,1999:blog-34323687.post-34870314911154235522007-11-15T20:46:00.000+00:002007-11-15T20:46:00.000+00:00Au contraire, Anonymous! I'm asking you to imagi...Au contraire, Anonymous! I'm asking you to imagine a Chinese, Saudi, and UAE (to name a few) economy without the Fed, for verily the Fed cares not about the consequences of its policy on their economy. Not that it it necessarily should, mind you; it just begs the question of why these economies continue to import US monetary policy when it is clearly ill-suited for their domestic needs.<BR/><BR/>And as for the international investor in financial assets? Well, the dual mandate is right there on the Fed's own website. You cannot say that you were not warned!Macro Manhttps://www.blogger.com/profile/12324967552369915949noreply@blogger.comtag:blogger.com,1999:blog-34323687.post-71250098673677522492007-11-15T20:27:00.000+00:002007-11-15T20:27:00.000+00:00MMNow of course you are asking me to imagine a US ...MM<BR/><BR/>Now of course you are asking me to imagine a US economy without the Fed.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-32591290507852390152007-11-15T19:42:00.000+00:002007-11-15T19:42:00.000+00:00OH, and as for the Swiss: Clueless, Helpless, Fru...OH, and as for the Swiss: Clueless, Helpless, Fruitless pretty much sums up the SNB.<BR/><BR/>As for Mr. Jen, I think his analysis is misplaced. There is no point propping up the dollar against the €, £, CAD, etc. when it is already being propped up against the RMB, AED, SAR, RUB etc. <BR/><BR/>Once the buck is tradin g closer to realistic levels against BWII members, THEN it is time to worry about the buck against the others. Not before.Macro Manhttps://www.blogger.com/profile/12324967552369915949noreply@blogger.comtag:blogger.com,1999:blog-34323687.post-48587420284606458022007-11-15T19:35:00.000+00:002007-11-15T19:35:00.000+00:00Anonymous #2, I think that from a purely domestic ...Anonymous #2, I think that from a purely domestic perspective, the Fed's mandate and its execution has been pretty good, overall. The US is a rich and prosperous country, and some of the cerdit must go to monetary policy-makers. Of course, the US is the world's largest economy and the dollar its most important currency. <BR/><BR/>I suppose the point that I'm trying to raise here is that the Fed's largely domestic focus is (or should be) broadly incompatible with the notion of the dollar as a store of value, given the inherentlty dilutive nature of Fed policy when compared to that of other CBs. Of course, the obvious rejoinder is that fiat currencies themselves cannot be stores of value per se, and are only worth holding insofar as they can be exchanged for valuable goods/services/assets. Given the breadth and depth of US asset markets, the dollar has indeed commanded a premium. However, now that we live in a world with a viable alternative, the diltuive nature of Fed policy should become a dominant determinant in the dollar's value, as indeed it has done for the past five years.<BR/><BR/>That having been said, OldVet, I am fairly confident that an end to Bretton Woods II will mean the end of the euro bull trend, for this cycle at least.<BR/><BR/>Speculative money that has heretofore gone into euros and sterling by virtue of their being 'anti-dollars' (and believe me, we're talking a lot of money here) will almost certainly be re-directed towards erstwhile BWII participants. AT the same time, one would presume that the end of BWII shoul;d to some degree slow the pace of reserve accumulation, and the concomitant price insensitive CB buying. And perhaps most importantly, the euro is approaching (though has yet to reach) the end of its 'easy' rally, when the ECB has desired a tightening of monetary conditions.<BR/><BR/>Once (and it may be six months away, but it is coming) the ECB desires easier monetary conditions, the euro will come under cyclical pressure. If this comes in the context of BWII dissolving, all the more reason for the euro to fall.Macro Manhttps://www.blogger.com/profile/12324967552369915949noreply@blogger.comtag:blogger.com,1999:blog-34323687.post-25085478414296423942007-11-15T19:34:00.000+00:002007-11-15T19:34:00.000+00:00Cursed by more imagination than information, I now...Cursed by more imagination than information, I now note MorgStan's Jen calling for massive G7 dollar prop intervention. No wonder dollar showing strength this week.<BR/>http://www.morganstanley.com/views/gsb/index.htmlAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-23733085959424697812007-11-15T19:14:00.000+00:002007-11-15T19:14:00.000+00:00Lower US interest rates has led to consumption ove...Lower US interest rates has led to consumption over savings and investment for years, and now Fed promises more of same. Trying belatedly to prop up employment through lower interest rates is unlikely to work, given lags in fixed investment decisions. Inflation certainly won't disappear with lower rates or lower Dollar.<BR/><BR/>Mercantilist peggers' inflation problems and high employment choices are inverse policy to Fed's in recent years. If pegger's uncouple somewhat and let currencies strengthen, it's hard to see why Euro would suffer or fall against the Dollar. Stronger currencies equal stronger markets for Euroland exports, offsetting US exports. <BR/><BR/>Where would Swiss fall in this array of virtuous and vicious as they change roles, potentially? In the Euroland bag, in your opinion?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-49900645318113164272007-11-15T19:05:00.000+00:002007-11-15T19:05:00.000+00:00Tend to agree that the record of different governo...Tend to agree that the record of different governors under various scenarios should have more impact in evaluating the excuse of a "Fed put". <BR/><BR/>Frankly the mandate is so slippery anyway " long run growth... long run potential....promote effectively ...long-term interest rates." that anything could be done, particularly, in the short term. It has been... and one thinks this flexibility is enjoyed and quite consciously so, with the sides of "the Fed put" box capable of being conjured into appearing and disappearing according to the audiences' willing credulity.<BR/><BR/>Other equally/more important factors are likely to be:<BR/>-the nature and quality of oversight and accountability <BR/>-the intellectual make up and influences upon Fed and governors<BR/>-political pressures, nature and intensity<BR/>-Treasury. Government.<BR/>-Reserve currency status<BR/>-consequences of policy<BR/>-actions coordinated or not of large dollar acquirers of holders<BR/><BR/>Would less flexibiity be better or work? That is another question.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-17964620207232437582007-11-15T16:18:00.000+00:002007-11-15T16:18:00.000+00:00Outstanding post, as usual.KeithOutstanding post, as usual.<BR/><BR/>KeithAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-42858994482312953942007-11-15T14:45:00.000+00:002007-11-15T14:45:00.000+00:00Bureaucrat, if you run some numbers I would be qui...Bureaucrat, if you run some numbers I would be quite intrested in seeing them, so please do share. Of course, the problem is establishing just what the inflation target part of the Taylor rule formula should be: core PCE 1.75%? headline PCE 2.5%? Who knows.<BR/><BR/>In any event, that they cut 50% in September with a) equities closer to the year's highs than lows, b) GDP in the midst of a 5% quarter<BR/>c) the dollar starting to come under pressure, and d) commodity prices rising sharply, promising uture inflation suggests that for the time being, the threshold to emphasize the growth over inflation mandat es was very low.Macro Manhttps://www.blogger.com/profile/12324967552369915949noreply@blogger.comtag:blogger.com,1999:blog-34323687.post-78444468835781451362007-11-15T14:23:00.000+00:002007-11-15T14:23:00.000+00:00MM,whether de facto the FED is paying less attenti...MM,<BR/>whether de facto the FED is paying less attention to inflation than other CBs is ultimately an empirical question that one could e.g. approach through looking at whether the US has lower coefficients on inflation gaps in Taylor rules than other countries. Maybe somebody's already done that, in which case it would be great to have the reference. Otherwise, as I'll probably run some regressions on that issue over the coming weeks anyway, I will be happy to share the results with your readers.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-34323687.post-45382241858513783522007-11-15T13:53:00.000+00:002007-11-15T13:53:00.000+00:00Regarding the inclusion of headline inflation in t...Regarding the inclusion of headline inflation in their forecast,I thought the same thing as you did MM, but then I read the passage in the speech pertaining to the "most appropriate pace of disinflation" which is essentially Ben saying "inflation may be high, but trust us, whithin 3 years we'll bring it back down". <BR/>If he wants us to believe him, he has to earn his spurs first, which is going to entail sacrificing a bit, not all, of the empolyment side of the mandate. For we have been told repeatedly that sustainded low inflation is the best way to ensure long run low employment. And I think thats right.<BR/>Great post MM.<BR/>RJAnonymousnoreply@blogger.com