Poor John Mauldin. He is familiar with Austrian economics; he sees the Federal Reserve take actions that just a few short years ago would have ensured the Fed Chairman’s membership in the Turnip Truck Society; he knows that economists are clueless when it comes to forecasting; in peddling his latest book, “Code Red,” he has no problem pointing out the dangers of the grandest of all monetary experiments ever; he can see the bubbles forming.
But throw him a little tease – show him a little leg from any member of the Board of Governors – and he can’t help himself; he jumps right back in, knowing that this time – despite the risk of contracting disease – his dreams will be safely fulfilled.
Charles I. Plosser, President of the Federal Reserve Bank of Philadelphia is Mauldin’s latest fatal attraction. Plosser delivered a speech at the recent Cato Institute’s 31st Annual Monetary Conference. Mauldin gushes at the hope he finds in the speech:
Some of you will want to read this deeply, but everyone should read the beginning and ending. I find this one of the most hopeful documents I have read in a long time. Think about the position of the person who delivered the speech. You are not alone in your desire to rein in the Fed. (Emphasis added)
Mauldin demonstrates his naïveté, claiming to be surprised that Cato would invite a President from the Fed into its world. He thinks he is going to a church social, when instead he has entered a cat house. Don’t be surprised, John; even those who work directly for the Cato Institute love central banking.
Now on to the speech, entitled “A Limited Central Bank.” Right off the bat, the title suggests the high level of cognitive dissonance in the speaker.
He begins by outlining the power vested in central banks, and that with such power must come some limits:
Yet, in recent years, we have seen many of the explicit and implicit limits stretched.
“Stretched” is a good word, if you define it as “infinitely beyond the wettest of wet dreams of the wildest professor at the University of Chicago while in his most drug-induced state.” In addition to the explosion in the balance sheet, Plosser identifies the issue of the composition of assets – including the targeting of specific industries.
I have spoken on a number of occasions about my concerns that these actions to purchase specific (non-Treasury) assets amounted to a form of credit allocation, which targets specific industries, sectors, or firms. These credit policies cross the boundary from monetary policy and venture into the realm of fiscal policy.
And after all, aren’t we all better off when congress and the president are responsible for fiscal policy?
I include in this category the purchases of mortgage-backed securities (MBS) as well as emergency lending under Section 13(3) of the Federal Reserve Act, in support of the bailouts, most notably of Bear Stearns and AIG.
I think he neglected to mention the bailout of Goldman Sachs, JPMorgan, Citibank, Bank of America, Wells Fargo, and every other major money-center bank in the country. Probably a bit of a stretch from the official mandate of the Fed – the one invented solely for public consumption.
Plosser goes on to make a fantastic statement – I am not being facetious; this is truly fantastic:
Let me begin by addressing the goals and objectives for the Federal Reserve. These have evolved over time. When the Fed was first established in 1913, the U.S. and the world were operating under a classical gold standard. Therefore, price stability was not among the stated goals in the original Federal Reserve Act.
Under a classical gold standard, price stability was not a concern. Imagine that!
Indeed, the primary objective in the preamble was to provide an “elastic currency.”
An “elastic currency” is nothing more than expanding credit beyond reserves – fractional reserve banking, if you will.
Now banks have practiced FRB for centuries, both within and without a central banking environment. Elastic currency was provided by banks – again, often with no central bank and no government guarantees.
So why was the Fed needed? The elastic currency concept already existed – the government did not invent it. Private banks were able to make currency as elastic as they wanted, limited only by the trust of their depositors and the creditworthiness of their debtors.
The Fed was needed for one reason: to backstop the banks – to protect the banks that extended lending beyond a prudent reserve ratio, or that made loans to creditors who later were unable to repay. The Fed came to existence to ensure that the banks could expand FRB to the maximum amount in order to maximize interest income, while at the same time providing a backstop with a printing press to ensure poor lending decisions did not result in negative sanctions – bankruptcy.
Plosser makes another truly fantastic statement; he mentions several positive attributes of a gold standard:
The gold standard had some desirable features. Domestic and international legal commitments regarding convertibility were important disciplining devices that were essential to the regime’s ability to deliver general price stability. The gold standard was a de facto rule that most people understood, and it allowed markets to function more efficiently because the price level was mostly stable.
Sadly, war got in the way:
But, the international gold standard began to unravel and was abandoned during World War I.
It was abandoned in order to finance that war, not because of that war. Cause and effect should be clearly understood. It is no coincidence that the bloodiest century in recorded history is also the century of central banking and democracy. Plosser neglects to mention this….
He comes to the present day, with the Fed operating under the so-called dual mandate of stable prices and maximum employment.
Let me point out that the instructions from Congress call for the FOMC to stress the “long run growth” of money and credit commensurate with the economy’s “long run potential.” There are many other things that Congress could have specified, but it chose not to do so. The act doesn’t talk about managing short-term credit allocation across sectors; it doesn’t mention inflating housing prices or other asset prices. It also doesn’t mention reducing short-term fluctuations in employment.
So, despite all of the “restrictions” placed by congress on the Fed, the Fed has somehow, mysteriously, strayed from its boundaries. Why has the Fed – Plosser’s Fed – done this? who is he criticizing?
Plosser readily admits that monetary policy has little effect on employment:
Most economists are dubious of the ability of monetary policy to predictably and precisely control employment in the short run, and there is a strong consensus that, in the long run, monetary policy cannot determine employment.
We all know that price stability has not been achieved either, as evidenced even by the government’s own statistics: the dollar has lost about 95% of its purchasing power since 1913, according to the BLS. (I guess the BLS hasn’t read the analysis by Matt Busigin as of yet, otherwise surely they would stop publishing such rubbish.)
Unable to effect employment and having failed at maintaining price stability, what is a lifelong central planner left to offer?
First, don’t expect so much:
When establishing the longer-term goals and objectives for any organization, and particularly one that serves the public, it is important that the goals be achievable. Assigning unachievable goals to organizations is a recipe for failure. For the Fed, it could mean a loss of public confidence. I fear that the public has come to expect too much from its central bank and too much from monetary policy, in particular.
Second, focus on only one variable…price stability:
I have concluded that it would be appropriate to redefine the Fed’s monetary policy goals to focus solely, or at least primarily, on price stability.
Now, he neglects to connect a couple of dots. Plosser himself pointed out that the definitive goal regarding employment came about only in 1978:
Congress established the current set of monetary policy goals in 1978. The amended Federal Reserve Act specifies the Fed “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
What then does the BLS have to say about price stability up to the period 1977? Well, the dollar lost about 85% of its purchasing power….
How to achieve price stability when it hasn’t been achieved in the past? Independence:
To meet even this narrow mandate, the central bank must have a fair amount of independence from the political process so that it can set policy for the long run without the pressure to print money as a substitute for tough fiscal choices. Good governance requires a healthy degree of separation between those responsible for taxes and expenditures and those responsible for printing money.
More remarkable statements: Plosser suggests something must change in order for the Fed to be independent…yet I thought it already was independent. Isn’t that what they say whenever they are asked?
Second, he has no problem using the phrase “printing money” to describe the activities of the Fed.
Plosser exalts the original design of the Fed, a design made to ensure decentralization and independence…wait…WHAT?
The original design of the Fed’s governance recognized the importance of this independence. Consider its decentralized, public-private structure, with Governors appointed by the U.S. President and confirmed by the Senate, and Fed presidents chosen by their boards of directors. This design helps ensure a diversity of views and a more decentralized governance structure that reduces the potential for abuses and capture by special interests or political agendas. It also reinforces the independence of monetary policymaking, which leads to better economic outcomes.
I guess Plosser never heard of Benjamin Strong:
He served as Governor of the Federal Reserve Bank of New York for 14 years until his death. Strong exerted great influence over the policy and actions of the entire Federal Reserve System. (Emphasis added)
Strong ran the Fed. Setting aside that a centralizing institution cannot be considered decentralized, the New York region, and therefore the governor of that region, is the only one that counts.
Back to Plosser:
Such independence in a democracy also necessitates that the central bank remain accountable. Its activities also need to be constrained in a manner that limits its discretionary authority.
They preach democracy while at the same time usurping power. You want democracy? Leave money and credit to the market – meaning to the people, acting as individuals or in voluntarily formed groups.
They preach limits to discretionary authority, yet do not offer the one possibility that will ensure limits on discretionary authority – free markets, where one’s authority extends no further than his demonstrated ability to profitably serve his fellow man, also known as customers.
But then what would a lifelong central planner do for a living?
He offers other possible constraints:
As I have already mentioned, the Fed has ventured into the realm of fiscal policy by its purchase programs of assets that target specific industries and individual firms. One way to circumscribe the range of activities a central bank can undertake is to limit the assets it can buy and hold.
My preference would be to limit Fed purchases to Treasury securities and return the Fed’s balance sheet to an all-Treasury portfolio. This would limit the ability of the Fed to engage in credit policies that target specific industries.
WAIT A MINUTE. JUST WAIT A MINUTE.
Isn’t he talking about targeting a specific industry – the industry of the state? The industry of war, death, destruction, spying, control, coercion, aggression, theft, and poverty. This is the industry he believes deserves support?
He has more to offer:
A third way to constrain central bank actions is to direct the monetary authority to conduct policy in a systematic, rule-like manner.
Rules. The Fed should operate on rules. But can’t a computer do this? Why do you need to waste money on economists?
Plosser answers the question – the rules should apply only in “normal times”:
One way this might work is to require the Fed to publicly describe how it will systematically conduct policy in normal times….
Rest assured the Fed will find a way to ensure that we never live in “normal times” again if this rule ever gets implemented.
My sense is that the recent difficulty the Fed has faced in trying to offer clear and transparent guidance on its current and future policy path stems from the fact that policymakers still desire to maintain discretion in setting monetary policy.
No. It is because they don’t know what they are doing.
And these know-nothings have the answer – just ask Plosser, who summarizes:
What is the answer? I see three: Simplify the goals. Constrain the tools. Make decisions more systematically. All three steps can lead to clearer communications and a better understanding on the part of the public.
I will offer my answer: stop the central planning of money and credit. End the Fed.
Plosser concludes with some recommendations – call them pie-in-the-sky:
Before concluding, I would like to say a few words about the role that the central bank plays in promoting financial stability.
Can an economist utter such words given the reality of the last 15 years, to say nothing about the last 100?
The Fed plays an important role as the lender of last resort, offering liquidity to solvent firms in times of extreme financial stress to forestall contagion and mitigate systemic risk.
Can an economist continue to pretend that, in 2008/2009, banks that were recipient of Fed largesse were solvent? None would mark-to-market, and they even had the rules changed so they wouldn’t have to do so. Had they been required to mark-to-market, the fallacy of solvency would have been visible for all to see.
Just as it is true for monetary policy, it is important to be clear about the Fed’s responsibilities for promoting financial stability. It is unrealistic to expect the central bank to alleviate all systemic risk in financial markets.
Why is this unrealistic? When was the last time the Fed allowed systemic risk to run its course? It would be unrealistic to expect otherwise given the track record.
Similarly, the central bank should set boundaries and guidelines for its lending policy that it can credibly commit to follow.
Don’t make me laugh. There isn’t one monetarist in a thousand worth his Ph.D. that would have said back in 2006 that the Fed would be credible if it quadrupled its balance sheet in four years. Yet the Fed has done this, with no end in sight. When it comes to the state, credibility is valued only when maintaining it doesn’t threaten state power.
If the Fed is asked by the fiscal authorities to intervene by allocating credit to particular firms or sectors of the economy, then the Treasury should take these assets off of the Fed’s balance sheet in exchange for Treasury securities.
This would, of course, only increase the government debt. So it won’t happen. I believe there is a higher possibility that the Fed will end up writing off its Treasury assets.
Many observers think financial instability is endemic to the financial industry, and therefore, it must be controlled through regulation and oversight.
No, financial instability is a consequence of governments and their policies, even those intended to reduce instability.
However, financial instability can also be a consequence of governments and their policies, even those intended to reduce instability.
Wait a minute – I just said that.
I can think of three ways in which central bank policies can increase the risks of financial instability.
No need to list three; there is only one: existence. Central banks increase the risks of financial instability merely by existing. But a member from the inside could never suggest this.
The Fed and other policymakers need to think more about the way their policies might contribute to financial instability.
Don’t bother; you will never come to the right conclusion. All centrally-planned policies contribute to instability – just ask Obama.
And Mauldin doesn’t come to the right conclusion either. He holds out hope because he believes Plosser has blown him a kiss and shown him a little leg.
John, don’t hold out such hope – it is a false hope. You will be greatly disappointed because, once again, after the fun is done, you will need to visit your doctor, who will subsequently prescribe antibiotics.
End the Fed.