FEDWATCH
Is the Demand for T-bills Driving Treasury Deposits at the Fed?
[Editor's note: Shostak employs a different measure of the money supply than the Rothbard-Salerno money supply measure used here. For a more full explanation, see here.]
On October 2016, the US Money Market Fund (MMF) industry underwent a reform with new requirements for US institutional prime and municipal MMFs becoming effective.
Under the new US MMF regulations, institutional prime and municipal MMFs are required to change from a fixed net asset value (NAV) to a floating NAV and adopt provisions to consider liquidity fees and redemption gates. However, government and Treasury MMFs were given a reprieve from these structural changes because of their perceived low risk and high liquidity.
RELATED: "Money Supply Growth Falls to 17-month Low in February"
The changes that took place in October were announced two years earlier. In response to this since the end of 2015, there was a massive increase in the demand for Treasury bills. Consequently, government deposits, or the cash balances, with the Federal Reserve jumped from $75 billion in October 2015 to $394.6 billion by November 2016 — an increase of 426.1%. An increase in government deposits with the Fed reduces the supply of cash in the federal funds market, all other things being equal.
Consequently, this puts an upward pressure on the federal funds rate. In order to keep this rate at the target, which was set by Fed policymakers, the US central bank is compelled to lift the money supply by buying assets.
Note that while the increase in government deposits does not change the money supply, the Fed’s policy to protect the federal funds rate target results in an increase in money supply. Indeed the yearly growth rate in AMS jumped from 3.4% in October 2015 to 16.7% by November 2016.
Using our model, we forecast that government deposits are likely to follow a horizontal trend during 2017 to 2018. After closing at $323.9 billion in February, the level of deposits is forecast to close at $359 billion by December. By November next year, the level is forecast to climb to $445 billion before settling at $388 billion by December next year. According to our model, which incorporates the effect of government deposits among other variables, the yearly growth rate of AMS forecast is to close at 7% by December versus 8.5% in January before settling at 8% by December next year.
How Trump Bailed Out Janet Yellen and the Federal Reserve — For Now
The biggest winner of the Trump presidency is also the most surprising: Federal Reserve Chairman Janet Yellen.
After all, Yellen was a constant target for criticism by Candidate Trump, going so far as to accuse her of being “more political than Hillary Clinton.” Beyond Mr. Trump’s barbed rhetoric, pundits such as Paul Krugman predicted that Trump’s ascendency would be disastrous for the US economy and the stock market in general, which would have wiped out the modest recovery that Yellen’s legacy depends on.
Almost a year after Trump’s election, the world looks quite different. Not only has Wall Street toasted the Donald’s victory, but the president continues to keep open the possibility of re-nominating Janet Yellen for a second term. Of course, given Trump’s surprisingly strong understanding of how current Fed-policy was a positive for the administration, perhaps this reversal should have been as predictable as Paul Krugman being wrong.
For Yellen, more important than Trump’s willingness to compliment her performance is what his presidency has done for the reputation of the Fed. Prior to this year, the Fed had been constantly forced to backtrack on planned interest rate hikes and downplay talk of balance sheet normalization due to economic stagnation.
For example, in 2016 the Fed was only able to hit one of its projected four interest rate hikes during the year, and that one came after the market surged following Trump’s election. Still, many traders were skeptical of the Fed’s forecast of three interest rate hikes. Earlier in the year, Yellen was even forced to admit that forward guidance, a communication tool that was favored by Ben Bernanke, no longer worked because people simply stopped taking the Fed’s projections seriously.
2017 has been a better one for those in the Eccles Building. The Fed is on schedule with its rate hikes and feels comfortable enough following through on its plans to slowly — very, very slowly — unravel its balance sheets that ballooned from various rounds of quantitative easing. While we are still years away from anything resembling normal pre-crisis monetary policy, at least the Fed has been able to make the appearance of trying to get there for the first time since 2008.
Why the change?
Well in spite of the Trump administration’s public frustrations in achieving legislative victories, it has seen success at one of the stated goals of former strategist Steve Bannon: the (partial) deconstruction of the administrative state.
As the Completive Enterprise Institute reported earlier this month, the Federal Register is at 45,678 pages — less than half of the 97,110 pages that existed during the Obama administration. While that is still an extraordinary amount of government red tape (the equivalent of over 50 copies of Human Action), it is a significant step in unraveling one of the most underreported disasters of Barack Obama’s tenure in DC. Further, executive orders made during Trump’s first weeks in office required agencies to eliminate rules prior to writing new ones, which has helped stymie the rate in which new rules are being written.
Not only has this led to saving tens of billions in regulatory compliance cost, but — coupled with continued hope for tax reform — it has been a major boon to business confidence. IECONOMICS finds business confidence at the highest it's been in 10 years.
Data: United States Business Confidence provided by IECONOMICS
Meanwhile, NFIB has finally found recovery from post-crisis lows.
Data: NFIB Small Business Trends Survey, September
In short, Trump hasn’t needed Congress to do some real good for economic activity — he just needed to not govern like Barack Obama.
The results from this renewed optimism in America’s economic landscape has been increased investment and employment — which have been routinely referenced by the Fed this year while announcing their policy decisions, over the objections of Minneapolis Fed Chair Neel Kashkari and other more dovish critics.
To their credit, in spite of their toxic advocacy for even easier-monetary policy, there is substance in Kashkari’s criticism. In spite of increased business confidence — itself partially grounded on inadequate tax reform that quite possibly may not come to fruition — wages outside of the financial sector and technology still lag — in no small part due to consequences of the very monetary policy hyper-doves are advocating. Meanwhile, while reduction of the regulatory code is a very important step, nothing has been done to address other systemic issues, such as Washington’s complete inability to curb its hedonistic addiction to debt — that too being subsidized by the Federal Reserve’s own policies. Not to mention the ever looming threat of a trade war being just a tweet away. And, of course, these gains have all been assisted directly by the Fed's accommodative monetary policy — a bubble is still a bubble, even if the resulting boom is a historically modest one.
In spite of these very real dangers to the US economy, it’s understandable why the economy is second only to his IQ in topics he enjoys bragging about. As such, with reports swirling that he will soon be making an announcement about next year’s Fed chair, it wouldn’t be surprising to see Trump maintain the status quo and re-nominate Janet Yellen. After all, it's one thing to attack the swamp from the outside, but quite another when you're in charge. Trump's campaign rhetoric made it clear that he understands what will happen when the Fed truly changes course, he's not going to want to be there when that "big fat bubble" pops.
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Questions Remain as the Fed Finally Begins to Reverse QE
Today the Federal Reserve announced that it will finally begin the process of reversing quantitative easing. Following the process it outlined earlier this year, the Fed will start allowing assets (Treasurys and mortgage-backed securities) to mature off its balance sheet, rather than re-investing them as had been its prior policy. The current plan is to start with a $10 billion roll off in October, and increasing quarterly until it reaches $50 billion by October of next year. Considering the Fed’s balance sheet currently stands at $4.5 trillion, the Fed is envisioning a slow, multi-year process. As Philadelphia Fed president Patrick Harker described it earlier this year, the goal is for it to be “the policy equivalent of watching paint dry.”
Of course the old saying about the “best laid plans of mice and men” also applies to central planners, and as Janet Yellen once again noted today, “policy is not on a pre-set course.” Should markets react negatively, as they did when Bernanke hinted at reducing their purchases in 2013, the markets have reason to expect the Fed to act. In fact, when asked, Yellen kept the door open to both lowering interest rates and stalling its roll off should market conditions worsen. In fact, it appears that markets are already betting on the Fed to not follow through on its projected December rate hike.
As the Fed has been signaling for months now that a taper was in the works, the mainstream narrative suggests that tapering has been priced in (though stocks dropped on the news.) There are still major questions left unanswered.
One of the biggest questions going forward is who will step up to replace the Fed’s purchasing power in the US Securities market? In the past, the US has been able to count on China to purchase US debt. Even before the Trump administration threatened the country with sanctions, China was selling off Treasurys in order to help prop up its struggling economy. With other nations also backing off from US debt, the hope is that investors will fill the gap. While the continued actions of the ECB, BOJ, and other central banks may make US debt more attractive in comparison, increased investments in bonds is likely to come at the expense of other assets.
Of course the noise of the Fed’s actions only serves to distract from the real issue, which is the continuing economic stagnation of the US economy. While Yellen continues to boast about modest employment gains, full-time employment remains lower than it was prior to the recession. Meanwhile, American’s personal debt has reached record highs — following the example of their government. How much of these gains are being fueled by credit and the false prosperity of inflated stocks and other assets? We’ll see.
For what it’s worth, the Fed itself — which is regularly overly-optimistic — doesn’t seem to have much faith in the future. It is now projecting long-term growth below 2%.
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Money-Supply Growth Drops Again — Falls to 108-Month Low
Growth in the supply of US dollars fell again in August, this time to a 108-month low of 4.2 percent. The last time the money supply grew at a smaller rate was during August 2008 — at a rate of 4.1 percent.
The money-supply metric used here — an "Austrian money supply" measure — is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure than M2. The Mises Institute now offers regular updates on this metric and its growth.
The "Austrian" measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler's checks, and retail money funds).
M2 growth also slowed in August, falling to 5.3 percent, a 75-month low.
Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of falling money-supply growth.
Thanks to the intervention of central banks, of course, money supply growth in recent decades has never gone into negative territory.
Nevertheless, as we can see in the graph, significant dips in growth rates show up in years prior to a economic bust or financial crisis.
For insights into what's affecting money supply growth, we can look at loan activity, such as the Federal Reserve's measure of industrial and commercial loans.
In July of this year, growth rate in loans fell to a 75-month low, dropping to 1.5 percent. In August, loan growth rebounded slightly, climbing back to 2.1 percent. Loan growth has not been this weak since April of 2011, in the wake of the last financial crisis.
We find similar trends in real estate loans and in consumer loans, although not to the same extent.
The current subdued rates of growth in the money supply suggests an economy in which lenders are holding back somewhat on making new loans, which itself suggests a lack of reliable borrowers due to a lackluster overall economy. This assessment, of course, is reinforced by the Federal Reserve's clear reluctance to wind down it's huge portfolio, and to end its ongoing policy of low-interest rates — concerned that any additional tightening might lead to a recession. Growth in consumer loans hit a 27-month low in August, and real estate loans hit a 28-month low during the same period.
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Why Is the Euro Still Gaining Against the Dollar?
The primary purposes of the incorrectly named “unconventional monetary policies” are to debase the currency, stoke inflation, and make exports more competitive. Printing money aims to solve structural imbalances by making currencies weaker.
In this race to zero in global currency wars, central banks today are “printing” more than $200 billion per month despite that the financial crisis passed a long time ago.
Currency wars are those that no one admits to waging, but everyone wants to fight in secret. The goal is to promote exports at the expense of trading partners.
Reality shows currency wars do not work, as imports become more expensive and other open economies become more competitive through technology. But central banks still like weak currencies — they help to avoid hard reform choices and create a transfer of wealth from savers to debtors.
The Euro Rallies
So how must the bureaucrats at the European Central Bank (ECB) feel when they see the euro rise against the U.S. dollar and all its main trading currencies by more than 12 percent in a year, despite all the talk about more easing? The ECB will keep buying 60 billion euro a month in bonds, maintain its zero interest-rate policy, and keep this “stimulus” as long as it takes, until inflation growth and GDP growth are stable.
Contrary to the wishes of the ECB, however, a strong euro is justified for several reasons. First, the European Union’s trade surplus is at record highs, and 75 percent of Eurozone trade happens between eurozone countries. Higher exports and the continued recovery of internal demand in European member countries strengthen the euro.
The third is the perception of weakness of the U.S. government and its inability to push through key reforms. This has weakened the dollar and by definition strengthened the other two large trading currencies, the euro and the Japanese yen.The second important factor is the relief rally after the French and Dutch elections. The fears of a euro breakup have been eliminated, or at least delayed, as pro-EU political parties won.
The Problems With a Strong Euro
However, a strong euro has very significant implications for the EU economy and the ECB’s policy.
The strong euro puts exports to its main outside trading partners — the United States (20.8 percent of exports in 2016) and China (9.7 percent) — at risk. Despite the ECB’s extreme monetary policy and a euro trading almost at parity with the dollar, exports to non-EU countries have stalled since 2013. GDP growth estimates for 2018 are falling due to a lower contribution of net exports.
The currency also has a high impact on tax revenues in Europe. The correlation between the euro–dollar exchange rate and the earnings estimates of the largest multinationals represented in the Stoxx Europe 600 Index is very high.
According to our estimates, a 10 percent rise of the euro against the dollar is equivalent to an 8 percent drop in earnings and leads to lower corporate tax revenues. From an investment perspective, as earnings drop, the European stock market goes from being relatively cheaper to becoming more expensive.
Investors and economists need to pay attention to these factors. If the euro continues to strengthen, the EU economic recovery is at risk. So the eurozone is stuck between a rock and a hard place. It cannot stop the stimulus because deficit spending governments cannot live with higher financing costs, and increasing the stimulus to weaken the currency simply doesn’t work anymore.
The only way out is structural reforms, but most governments are afraid of them even in good times, let alone when the going gets tough.
Originally published by Epoch Times. Reprinted with permission.
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Stanley Fischer’s Well-Timed Fed Exit
Fed vice-chair Stanley Fischer’s surprise announcement of early retirement triggers the obvious question as to whether this could be the fore-runner to a serious market and economic deterioration ahead. Monetary bureaucrats, even if signally bad at counter-cyclical fine tuning, sometimes have a reputation for intuition about how to time their own career moves ahead of crisis. In this case, such suspicion may be wide of the mark given the personal circumstances. Even so, the exit of a Fed Vice-Chair, who in many respects has been the pioneer and the dean of the prevailing doctrine in the global central bankers club, is pause for thought.
The Early Years
When Professor Fischer published his famous paper “On Activist Monetary Policy with Rational Expectations” (NBER working paper no. 341, April 1979), the fiat money world was well into the third stage of disorder following the collapse of the international gold standard in 1914. But things were at a temporary resting point where the skies seemed to be getting clearer. After the violent terminal storms of the gold exchange standard (early 20s to early 30s), and then of the Bretton Woods System, it seemed to many that the “monetarist revolutionaries” had found a better practical monetary navigation route. The Bundesbank, the Federal Reserve, the Swiss National Bank, and even the Bank of Japan were pursuing an ersatz gold rule of low percentage increases in the monetary base or a related aggregate.
Fischer vs. the Monetarists
Despite the optimism at large, Fischer issued a challenge. The monetarist rules (x per cent growth of the chosen monetary aggregate) were doomed to fail when the underlying demand for money and monetary base in particular was so unstable.
Fischer rejected the new popular view (in the late 1970s) of the fashionable “classical economists” (for example Robert Barro) who argued that under market rationality monetary policy was powerless to influence the real economy. All the various trade-offs hypothesized by the Keynesian economists of the previous decade and pursued in part had been based on a view that central bankers could take the public by surprise (who would not realize what they were “up to” until later on). But once the public knew all Keynesian manipulations could not be effective.
In contrast, Fischer purported to demonstrate that if wages were rigid (most likely due to the existence of long-term contracts), then even given rational expectations, monetary policy could stimulate the real economy.
And so Professor Fischer, on the basis of his pioneering neo-Keynesian creed, preached that, yes, central bankers could and should pursue activist contra-cyclical strategies, especially when shocks were large and obvious. But yes, he also recognized that fine-tuning had its dangers and could morph into a long-run rising inflation rate, and so he recommended that policy be bound by the setting of a low inflation target. These ideas were in turn taken up and worked on by leading disciples (students) of Stanley Fischer, including Ben Bernanke and Mario Draghi.
The Birth of the 2% Inflation Standard
And so the fourth stage of fiat money disorder was born — what we may describe as the “global 2% inflation standard”. The prior monetarist experiments faded away in the decade following publication of Fischer’s paper (Paul Volcker abandoned monetarism by 1982, and the Bundesbank was the last hold-out in the year before the launch of the euro). At a stretch we could call this fourth stage the “Fischerian age of monetary policy”. Even though its author is now retiring, the outlook is for this stage to move eventually into a much more vicious sub-stage in which inflation rises far above the levels which the central bankers are purporting to target and the forces of rationality greeted by the classical revivalists have been completely trumped by powerful irrational forces which typify asset price inflation..
And all of this does not depend on who exactly President Trump decides to nominate in Fischer’s and Yellen’s place in coming months, even though there are reasons to speculate that the choice is likely to be pro-3% growth with the near-term target of avoiding defeat in next year’s mid-term elections. The bigger issue is that the so-called 2% inflation target belongs to a collection of fables under the title of the Emperor’s New Clothes. In today’s monetary environment where monetary base has been totally dislocated from the pivot of the monetary system (e.g., there's no stable demand, distinctive qualities of base money are virtually eradicated, and both supply and demand are boated by QE) there is no basis – other than expectation inertia – to view prices of goods and services as anchored.
At the best of times no one knew the precise relationship between monetary aggregates and prices — and indeed under the gold standard or monetarism no one pretended to have the price path under control; at best money was under control and that should foster some long-run tendency for prices to return to the mean, but there was no assurance of this. Strikingly the “Fischerians” have lost all sight of the natural rhythm of prices as responding to fluctuations in the pace of globalization, productivity growth, and of course the business cycle.
There is every reason to believe that expectation inertia will snap at some point in the future. And the root combination of monetary disorder — a Federal budget deficit of 4-5-6% of GDP at a cyclical peak, a Federal Reserve determined to hold down rates and manage the government bond markets, an administration favoring a weak dollar — there are grounds for fearing a lurch of the monetary train towards high inflation, albeit possibly beyond the next business cycle trough. And all of that despite the pride of Stanley Fischer in his resignation letter to President Trump:
During my time on the Board, the economy has continued to strengthen, providing millions of additional jobs for working Americans. Informed by the lessons of the recent financial ciris, we have buildt upon earlier steps to make the financial system stronger and more resilient and better able to provide the credit so vital to the prosperity of our country’s households and businesses.
Power corrupts, and Washington corrupts absolutely. How can anyone pretend to have learnt the lessons and achieved the results until at least one long business cycle under the given monetary regime has been completed? Only then can all the mal-investment be counted and the financial quake or hurricane damage assessed.
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Trump's Historic Opportunity with the Federal Reserve
And then there were three.
Today Stanley Fischer submitted his letter of resignation from the Federal Reserve’s Board of Governors, effective next month, the second such resignation of Donald Trump’s presidency. While Fischer’s term as Vice Chairman of the Fed was set to end next year, he had the ability to serve as a governor through 2020. Along with Trump’s decision next year on whether to replace Janet Yellen as the Fed’s chair, this means Trumps will have the opportunity to appoint five of seven governors to America’s central bank.
Given that the position holds a 14-year term, it is unusual for a president to have the opportunity to make so many appointments. As Diane Swonk of DS Economics noted, “It’s the largest potential regime change in the leadership of the Fed since 1936.”
Of course the question is now whether a change in personnel will lead to a change in policy.
Trump has already taken steps to fill one of the vacancies, nominating Randal Quarles earlier this year. Quarles, a former Bush-era Treasury official turned investment banker, will be taking the specific role of Fed vice chair of supervision. As a vocal critic of Dodd-Frank, and the Volker Rule in particular, Quarles may help relieve some of the regulatory burden on financial institutions, but his views on monetary policy are less clear. He has also voiced his support for rules-based monetary policy, though he has distanced himself to the specific proposal of the “Taylor Rule.” Given the growing consensus building for NGDP-targeting, and Republicans in Congress advocating for rules-based Fed reform, Quarles could become a supporter from within the central bank. All in all though, Quarles is seen by many observes as a bland Fed-appointment.
More concerning are the views of Marvin Goodfriend, who has been reported to be a front runner for one of the Fed vacancies. An economics professor at Carnegie Mellon University and former director of research at the Richmond Fed, Goodfriend has a traditional central banker background and the dangers that comes with it. In 2016, Goodfriend made an impassioned plea for the Fed to consider negative-interest rates:
The zero interest bound is an encumbrance on monetary policy to be removed, much as the gold standard and the fixed foreign exchange rate encumbrances were removed, to free the price level from the destabilizing influence of a relative price over which monetary policy has little control—in this case, so movements in the intertemporal terms of trade can be reflected fully in interest rate policy to stabilize employment and inflation over the business cycle.
Since negative interest rates usually coincide with greater use of cash (and personal vaults), Goodfriend went so far as to suggest the Fed should consider devaluing the value of printed bank notes. A $10 bill would buy less than a $10 debit card transaction, opening up a new front in the ongoing war on cash.
Given his radical views on monetary policy, it’s not hyperbole to suggest that Goodfriend’s nomination would represent a genuine danger to the economic wellbeing of every American citizen – or at least those outside of the financial services industry.
Unfortunately, even if Goodfriend doesn’t get the nod, it’s unlikely Trump will nominate anyone who understands the negative consequences of our artificially low interest rate environment. Though Candidate Trump demonstrated remarkable savvy when it came to how the actions of Bernanke and Yellen hurt Americans, as President Trump he has consistently indicated a desire to keep the “big fat bubble” going. Such a desire obviously fits the self-interest of the White House, but with long-term consequences for the base that elected him.
The only hope for a change in direction from the Administration is for Trump to stop listening to his Goldman Guys and instead lean on the team that helped get him to the White House. As Tommy Behkne noted last November, Trump had managed to surround himself with a number of Fed skeptics during his campaign, and even considered Austrian-friendly John Allison for Treasury Secretary.
Given the historic opportunity he has with the Fed, if Trump chooses to return to those roots, he could do severe damage to the swamp — all without passing a single piece of legislation through Congress.
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Stanley Fischer Is Out at the Fed
Fed Vice Chair and Yellen ally Stanely Fischer announced his unexpected resignation today, citing “personal reasons.” His term as a Fed governor wasn’t to be over until 2020 and his vice chairmanship was to end June of next year.
Fischer was one of the three most important Fed members, the other two being Yellen herself and the New York Fed’s William Dudley. The WSJ reports:
Mr. Fischer came to the Fed in 2014 a luminary in central banking, having taught many leading policy makers during a more-than two decade career as a professor at the Massachusetts Institute of Technology specializing in international economics. His students included European Central Bank President Mario Draghi and former Fed Chairman Ben Bernanke.
Mr. Fischer also ran a central bank—the Bank of Israel—from 2005 to 2013, held a senior post at the International Monetary Fund and served as a Citigroup vice chairman.
In terms of the insider status of these central bankers, Mr. Fischer was “Mr. Establishment.” Well educated in the machinations of how to control an economy from the top, Fischer was an expert bureaucrat. On paper, Fischer was among the most qualified in the world to be tasked with impossible role of making us more prosperous by diktat.
In reality, Fischer, to the extent he had a marked influence on central bankers like Draghi, Bernanke, Yellen, and so many others, was a key player in the boom-and-bust system of modern monetary economics. Under his watch, we had two major and devastating recessions— the cause of which was not Fischer’s failure individually, but the inflationary framework that pervades them all.
Fischer was considered to have leaned “hawkish” by the financial press. In the old days of Paul Volcker, a hawk was one wary of dangers of rising inflation. This was juxtaposed to a dove, who would downplay the dangers of inflation and advise greater monetary expansion. But in the post-crisis era of the so-called “new normal,” where interest rates are to remain absurdly low and inflation must be targeted at 2%, the hawks have long gone extinct. Fischer was no hawk, he was a cheerleader of the quadrupling of the Fed’s balance sheet, an advocate of unprecedented credit creation, and a hater of sound money.
It remains to be seen where Fischer will go next. But his undying advocacy of the use of central banking to tinker with and manage the economy will live on.
See also:
- "The Fed Wants to Test Drive Negative Interest Rates" by Joseph Salerno
- "Stanley Fischer's Eureka Moment" by C.Jay Engel
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Bank of Canada Raises Interest Rates … Again
For the second time in less than two months, the Bank of Canada has raised interest rates.
On Wednesday, the central bank raised its overnight lending rate by a quarter per cent to 1 per cent.
The move surprised many who weren’t expecting a rate increase until later this Autumn.
Just like last time, the rationale behind higher rates was centred around the Bank of Canada’s belief that the economy is growing faster than expected.
Bank of Canada Governor Stephen Poloz said, “The level of GDP growth is now higher than the bank expected.”
Of course, this assumes that GDP measures anything.
The Canadian loonie surged after the announcement, climbing to 82 cents U.S.
The decision reinforces the message that easy money and low-interest rates are coming to an end. Of course, the bursting of Canada’s real estate bubble could reverse direction for the bank, using these recent rate gains as leverage to cut rates in order to “stimulate” the deflating economy.
But until then, analysts are expecting more rate hikes since many have confused consumer indebtedness and rising prices as economic strength.
The Bank of Canada won’t confirm these predictions since, according to the central bank’s statement, price controls on interest rates are, “predetermined and will be guided by incoming economic data and financial market developments.”
Of course, the Bank of Canada isn’t clueless when it comes to higher rates and indebted Canadian households. In the rate hike statement, the bank promised that “close attention will be paid to the sensitivity of the economy to higher interest rates,” given “elevated household indebtedness.”
The bank’s next scheduled rate-setting is Oct. 25.
All in all, today’s announcement puts interest rates back to where they were in January 2015, before Poloz made two surprising “emergency rate cuts” to deal with falling oil prices.
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Bank of Mexico: Bread Today, Hunger Tomorrow
In April 2017, the Bank of Mexico transferred an unprecedented figure to the federal government: 321,653 billion Mexican pesos from its operating surplus. How much is this figure? It is equivalent to 1.7% of Mexico’s GDP — 25% of Guatemala’s GDP — and to 22% of the total revenue budget of the Mexican government.
What is Banxico’s Operating Surplus?
Essentially all of Banxico’s profits are a result of the appreciation in the value of the bank’s foreign exchange reserves in pesos. At the beginning of 2016, the Bank of Mexico’s dollar reserve was of 176,736 billion dollars. By the end of 2016, the bank had almost the same amount in reserves. However, in January the peso was trading at 17.35 to the dollar, and in December at 20.62 a dollar.
The Mexican peso depreciated by 19% in 2016. As a consequence, the value of Banxico’s foreign exchange reserves reported a gain of 582.8 billion pesos. It is from this profit that Banxico transferred the 321,653 billion to the Mexican federal government — a transfer the bank was obligated to carry out as established in article 55 of the Banxico law by no later than April of each year.
A Blessing for Public Finances
This “gift” that the central government received came as a blessing to a government that had announced a modest fiscal consolidation plan. It is important to take into account that from early 2013 until the end of 2016, the Mexican public debt went from 5202.77 billion pesos to 8657.62 billion.
By legal provision, 70% of the operative surplus that Banxico transferred to the Mexican government must be directed to repayment of debt. Undoubtedly, the aid fell from thin air: the operative surplus came from the peso’s depreciation caused by Donald Trump’s victory last November.
Will Banxico Continue to Profit?
What will happen now that the peso is appreciating against the dollar? If we review the Banxico’s results from the valuation of its foreign currency reserves as a consequence of the variation in the exchange rate, we find that in the first quarter of 2017 Banxico lost 310,911 billion pesos. This means that only in the first quarter of the year Banxico lost 53% of what it earned in 2016. This is not a reason to believe that Banxico is going bankrupt, but the bank is definitely decapitalizing.
What Should We Expect for the End of the Year?
Everything depends on the trend of the Mexican peso against the dollar. Experts do not expect a strong appreciation in the rest of the year. The high inflation rate does not suggest that the peso can appreciate too much. There are only two things that are certain: Banxico will report operational losses this year, and the Mexican government will not receive another “gift” in 2018 to pay for the public debt. The government will have to tighten its belt if it wants to reduce the high level of public debt it has.
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Mario Draghi’s Fatal Conceit
On 23 August 2017, the president of the European Central Bank (ECB) gave a speech titled “Connecting research and policy making” at the annual assembly of the winners of the Nobel Price for Economics in Lindau, Germany.1 What Mr Draghi talked about on this occasion — and especially what he didn’t talk about — was quite revealing.
Any analysis of the causes of the latest financial and economic crisis is conspicuously absent from Mr Draghi’s remarks. One gets the impression that the crisis came basically unexpected, out of the blue. There is no mention of the role of central banks, the monopoly producers of unbacked paper (or: fiat) money, played for the crisis.
No word that central banks had for many years manipulated downwards interest rates — accompanied by an excessive increase in credit and money supply — causing an unsustainable “boom.” When the bust set in — triggered by the spreading of the US subprime crisis across the globe — the ugly consequences of this central bank monetary policy came to the surface.
In the bust, many governments, banks and consumers in the euro area found themselves financially overstretched. The economies of Southern Europe especially do not only suffer from malinvestment on a grand scale, they also found themselves in a situation in which they have lost their competitiveness.
Mr Draghi, however, doesn’t deal with such unpleasant details. Instead, he lets his audience know how well the ECB pursued a policy of "crisis solution." His narrative is straightforward: Without the ECB’s bold actions, the euro area would have fallen into recession-depression, perhaps the euro area would have broken apart.
The analogy to such a line of argumentation would be praising a drug dealer, who provides the drug addict (who became a drug addict because of him) with just another shot. Repeated consumption of drugs does not heal but damages drug addict. Who would applaud what the drug dealer does? Likewise: would it be appropriate to praise the ECB’s action?
Mr Draghi presents himself as a fairly modest, intellectually ‘undogmatic’ central bank president stressing the importance of the insights produced by economic research for real life monetary policy making (thereby dutifully applauding the output of the economics profession). But the policy maker’s approach is far from being scientifically impartial.
Draghi's Flawed Methods
Today’s economics research — as it is pursued, and taught, by leading mainstream economists — rests on a scientific method that is borrowed from natural science and builds on positivism-empiricism-falsificationism.2 This approach, used in economics, does not only suffer from logical inconsistencies, its embedded skepticism and relativism has, in fact, has let economics astray.
Under the influence of positivism-empiricism-falsificationism economic theory – in particular monetary theory and financial market theory – has become the intellectual stirrup-holder of central banking, legitimizing the issuance of fiat money, the policy of manipulating the interest rate, the idea of making the financial system ‘safer’ through regulation.
In this vein, Mr Draghi praises especially the independence of central banks — for it would shield central bankers from destabilizing political outside influence. One really wonders how this argument — one-sided as it is — could find acceptance, especially in view of the fact that independent central banks have caused the great crisis in the first place.
The Central Bank's Many Friends
Why is there hardly any public opposition to Mr Draghi’s narrative? Well, a great deal of experts on monetary policy — coming mostly from government sponsored universities and research institutes — tends to be die-hard supporters of central banking. The majority of them would not find any fundamental, that is economic or ethic, flaw with it.
These so-called “monetary policy experts,” devoting so much time and energy for becoming and remaining an expert on monetary policy, unhesitatingly favor and accept without reservation the very principles on which central banking rests: the state’s coercive money production monopoly and all the measures to assert and defend it.
The upshot of such a mindset is this: “Once the apparatus is established, its future development will be shaped by what those who have chosen to serve it regard as its needs,”3 as F.A. Hayek explained the irrepressible expansionary nature of a monopolistic government agency – like a central bank.
Experts, keenly catering to the needs of the state and the banks, will make monetary policy increasingly complex and incomprehensible to the general public. Just think about the confusing abbreviations the ECB uses such as, say, APP, QE, CBPP, OMT, LTRO, TLTRO, ELA etc.4 In this way central bankers effectively sneak themselves out from public and parliamentary control.
Has the ECB Violated its Mandate?
It comes therefore as no surprise Mr Draghi hails “non-standard policy measures” such as quantitative easing through which the central bank subsidizes financially ailing governments and banks in particular. Mr Draghi, however, does not leave it at that. He also suggests that monetary policy should shake off remaining restrictions that hamper policy maker’s discretion:
[W]hen the world changes as it did ten years ago, policies, especially monetary policy, need to be adjusted. Such an adjustment, never easy, requires unprejudiced, honest assessment of the new realities with clear eyes, unencumbered by the defence of previously held paradigms that have lost any explanatory power.
These remarks come presumably because the German Constitutional Court has found indications that the ECB’s government bond purchases may violate EU law and has asked the European Court of Justice to make a ruling. The German judges say that ECB bond buys may go beyond the central bank's mandate and inhibit euro zone members' activities.
The issue is no doubt delicate: If the ECB is prohibited from buying government bonds (let alone reverse its purchases), all hell may break loose in the euro area: Many government and banks would find it increasingly difficult to roll-over their maturing debt and take on new loans at affordable interest rates. The euro project would immediately find itself in hot water.
Without a monetary policy of ultra-low interest rates and bailing out struggling borrowers by printing up new money (or promising to do so, if needed) the euro project would already have gone belly up. So far the ECB has indeed successfully concealed that the pipe dream of successfully creating and running a single fiat currency has failed.
The crucial question in this context is, however: What has changed in economics in the last ten years? Unfortunately, economists that follows the doctrine of positivism-empiricism-falsificationism feel encouraged to question, even reject, the idea that there are immutable economic laws, preferring the notion that ‘things change’ that ‘everything is possible’.
However, sound economics tells us that there are iron laws of human action. For instance, a rise in the quantity of money does not make an economy richer, it merely reduces the marginal utility of the money unit, thus reducing its purchasing power; or: suppressing the interest rate through the central bank must result in malinvestments and boom and bust.
In other words: Sound economics tells us that central bankers do not pursue the greater good. They debase the currency; slyly redistribute income and wealth; benefit some groups at the expense of others; help the state to expand, to become a deep state at the expense of individual freedom; make people run into ever greater indebtedness.
What central bankers really do is cause a "planned chaos." Unfortunately, the damages they create — such as, say, inflation, speculation, recession, mass unemployment etc. — are regularly and falsely attributed to the workings of the free market, thereby discouraging and eroding peoples’ confidence in private initiative and free enterprise.
The failure of such interventionism — of which central bank monetary policy is an example par excellence — does not deter its supporters. On the contrary: They feel emboldened to pursue their interventionist course ever more boldly and aggressively to achieve their desired objectives. Mr Draghi made a case in point when he said in July 2012:
“[W]e think the euro is irreversible” and “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”5 Hayek’s warning in his book Fatal Conceit (1988) goes unheard: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."6
Mr Draghi’s speech should not convince us that monetary policy rests on sound economics, or that the ECB works for the greater good. If anything, it shows that economics has been twisted and deformed to service the needs of the state and its central bank – which increasingly erodes what little is left of the free market to keep the fiat money system going.
Holding up the fiat euro will result in a coercive redistribution of income and wealth among people, within and across national borders, to an extent historically unprecedented in times of piece. As a tool of an effectively anti-democratic policy, the single European currency will remain a source of interminable conflict, injustice, and it will be a drag on peoples’ prosperity.
- 1. See Draghi, M., The interdependence of research and policymaking, speech at the Lindau Nobel Laureate Meeting, Lindau, Germany, 23 August 2017.
- 2. For a critical analysis see Hoppe, H.-H. (2006), Austrian Rationalism in the Age of the Decline of Positivism, in: The Economics and Ethics of Private Property. Studies in Political Economy and Philosophy, 2nd edition, Ludwig von Mises Institute, Auburn, US Alabama, pp. 347 – 379.
- 3. Hayek, F. A. v. (1960), The Constitution of Liberty, The University of Chicago Press, Chicago, p. 291.
- 4. APP = Asset Purchase Programme, QE = quantitative easing (issuing new money by purchasing bonds), CBPP = Covered Bond Purchase Programme, OMT = Outright Monetary Transactions, LTRO = Long-term Refinancing Operations, TLTRO = Targeted Long-term Refinancing Operations, ELA = Emergency Liquidity Assistance.
- 5. Draghi, M., Verbatim of the remarks made by Mario Draghi, speech held at the Global Investment Conference in London, 26 July 2012.
- 6. Hayek, F. A. v. (1988), Fatal Conceit. The Errors of Socialism, edited by W. W. Bartley, III, Routledge, London, p. 76.
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