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Christopher Mahoney
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I spent eight years at Bank of America in New York (1978-86) covering Wall Street, then moved to Moody's Investors Service where I worked for 22 years, covering banks, sovereigns and corporates. I chaired the Credit Policy Committee for four years. I retired in 2007 as vice chairman. PLEASE... More
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Capitalism and Freeedom
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  • The Taper: Monetary Nonfeasance

    The Fed's long-awaited taper has finally begun.


    Having added $1 trillion to its assets in 2013, and having failed to achieve either of its statutory mandates, the Fed has decided to reduce purchases while predicting eventual victory: "The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate." Not tomorrow, but someday.

    And what about deflation risk, Bernanke's personal bete noir? "The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term." "Monitoring" will prevent deflation; that's a new policy tool. Bernanke said today that "inflation can't be picked up and moved where you want it." This from the man who said that a central bank could always create inflation using the printing press.

    It is noteworthy that, unlike Draghi who talks through all of the data including money growth, Bernanke does not. This saves him from having to explain why he has no control over money growth. Instead he repeats the line that the Fed is providing a "highly accommodative stance of monetary policy". Which is actually not true, when we are looking at 6% money growth, 1% inflation and 3% nominal growth. That is not a highly accommodative stance.

    In point of fact, the Fed has been tightening for the past two years, with M2 growth falling from 10.5% to 6.0%, inflation falling from 2.0% to 1.1%, and nominal growth from 5% to 3% (YoY). QE3 has had no impact on money growth. At present, using its current policy instruments, the Fed has no control over the independent variables in the Quantity Theory: the money supply and velocity. This is why nominal GDP has been sliding sideways.

    Where is Chairman-to-be Janet Yellen in all this? We don't know. Bernanke says that she is on board with tapering, although I doubt it. I think that she is keeping a low profile until she takes the helm. Then we will find out what she really thinks.

    I hope that Obama nominates Stanley Fischer* as vice chair, which would add a lot of heft to a weak team, and might add some firepower to the doves. He's a monetarist, not an Austrian. At MIT, he was the thesis adviser for Ben Bernanke, Mario Draghi, and Greg Mankiw. You can't beat that!


    *Who would be the first African native to sit on the FOMC.


    Dec 18 10:52 PM | Link | Comment!
  • Why China Behaves So Badly

    Western observers say that China's behavior is "puzzling", and that its policy goals are "enigmatic". In fact, China's behavior is neither puzzling nor enigmatic; its behavior is shrewd, pragmatic and realist. China's internal and external behavior can be explained once one grasps that China is a rational actor operating under enormous economic pressure.

    Below are some of China's sins against the "international community":

    >UN obstructionism on many important matters such as nuclear proliferation;

    >Jingoist, xenophobic ideology at home and abroad;

    >Pursuit of regional hegemony, bullying regional neighbors;
    >Support for the evil Kim regime and its multitude of international provocations;

    >Militarism, military buildup, military threats;

    >Authoritarian domestic policy;

    >Abysmal human rights record: Tibet, Uighurs, Falun Gong, prison factories, etc.

    >Currency manipulation;

    >Threats to stop buying US Treasuries and to dump the dollar;

    >Unfair trade policies, mercantilism, flouting of WTO;
    >Massive intellectual theft.

    All of this behavior can be explained.

    China was a filthy dirt-poor agricultural nation of half-starved peasants when Chairman Mao died in 1976. Looking at China's weak position in the world at that time, Deng Xiaoping made the decision that a poor China could not be a strong China. Under Deng's leadership, the CCP launched a program of export-led industrialization which has continued uninterrupted to this day. Like Japan's a century earlier, China's modernization proceeded at a rapid pace. Starting with modest experiments in Guangdong and Shanghai, China quickly built an industrial economy that is now the second largest in the world, and will soon be the the largest. The success of Deng's plan has been nothing short of amazing.

    The CCP's plan then and now was to free China's one billion peasants from the poverty of low-productivity agriculture, and to channel this bottomless reservoir of low-cost labor into manufacturing. The overarching challenge is to match the constant inflow of low-skilled peasants from the west with the creation of new manufacturing jobs in the east. This is no small task: it requires rapid real growth year in and year out, and massive infrastructure investment. As the model is export-led and focused on manufacturing, it requires ever-higher manufactured exports. And therein lies the world's "China Problem".

    China's manufacturing potential is so huge that within a few decades its output could exceed that of the the rest of the world combined. The world's central problem is that China is simply too big to be neatly inserted into global trading system. When countries like Guatemala or Bangladesh seek to grow exports, they can do so without affecting markets or hurting competitors. By contrast, China at its full potential is a Panzer tank at Tiffany's. For China to succeed in implementing its development plan, it will have to destroy the world. China's national development strategy compels it to wreck everyone else's manufacturing economy. This is economic warfare, with Chinese characteristics.

    China has succeeded in massive export growth without currency appreciation by an idiosyncratic set of economic policies. China has ignored virtually all of the self-serving economic precepts of the West, which prescribe open capital accounts, elimination of currency controls, and freely-floating exchange rates. It was this suicidal advice that caused the East Asian financial crisis of 1997-98, which China survived unscathed.

    China's more prudent policy has been to: maintain very large external reserves; impose capital and exchange controls; peg its currency to the (weak) dollar; and mop up currency inflows and park them in the reserve account. No manufactured imports, thank you, just exports and an ever-greater reserve mountain. This unorthodox policy has enabled one of the greatest growth stories in modern economic history.

    So, an American will scratch his head and ask: Why does the US allow China to undersell its manufacturing sector, and to capture entire markets? How can the US permit the price of its unskilled labor to be globalized? What are American high school graduates supposed to do for a living? Why doesn't the US impose punitive tariffs as punishment for China's mercantilist policies? The answer to these questions is that China has used a variety of geopolitical maneuvers to keep the West off-balance and confused.

    China simply cannot allow the West to focus its attention on China's trade policies. She must do whatever it takes to distract, confuse and otherwise change the subject. China has a myriad of geopolitical levers at her command to divert the world's attention. (which I have listed above).

    The more trouble China creates, the more the West is distracted. When Joe Biden flies to Beijing to talk about trade, China declares an air defense zone in the East China Sea. What does Biden end up talking about? The air defense zone; trade policy is forgotten. The ADIZ crisis was manufactured to prevent trade negotiations.

    China explains its international behavior as anti-hegemonist, but that is a smokescreen for self-interest. China doesn't care very much about peripheral things like Sudan, Iran or the Middle East; what she cares about is international leverage. When western leaders huddle to discuss the latest crisis, what do they usually end up talking about? How to get China to cooperate with the "international community". The inevitable upshot: someone flies to Beijing to beg for China's help. The small price to pay for China's "help": ignore China's trade surplus.

    The EU wants to talk about non-tariff trade barriers? China arrests some hapless poet, which changes the subject. Other available "negotiating" tools: launch a new weapon; stake a new territorial claim; foment anti-Japanese protests; have North Korea shoot a rocket over Japan, or shell a South Korean fishing village. China explains much of its antisocial behavior as a response to domestic "public opinion"--which she manipulates at will. Chinese nationalist fervor serves the state, discourages dissent, and prompts Western "concern": providing yet another reason not to press too hard on trade. North Korea is just an extension of this policy by proxy.

    China pursues a policy of provocation, poking at the rest of the world, particularly the US Congress. Do you want to prevent Iran from going nuclear? Do you want peace in the East China Sea? Do you want to have influence over the Kim Dynasty? Do you want internet freedom? Do you want a free Tibet? Do you want to sell your country's products in China? Then you must go to Beijing and beg. Begging is your only leverage; pleading is your only strategy.

    I offer above an explanation for China's bad behavior. I can also suggest a solution: impose tariffs on Chinese exports. If China retaliates by selling dollars and Treasuries, she will have done exactly what we desire: America needs a stronger yuan, a weaker dollar, and a revived manufacturing sector to employ our unskilled labor. As a society, we cannot allow the price of our unskilled and semiskilled labor to be globalized. (Raising the minimum wage only makes China more competitive.)

    Another benefit to "fair trade with China" is that, by wielding a big stick (tariffs) and playing the international bad boy, America regains geostrategic leverage beyond trade policy. All of a sudden, the Politburo would have to worry about America's behavior. Problems such as North Korea would become more tractable.

    But what about America's treaty obligations under WTO? A "fair trade" policy involves what is known as "national treatment": we will trade with you as you trade with us. To confront China's realpolitik, the US needs to start thinking and acting like a normal country which protects its own interests and makes no pretensions otherwise.

    Dec 16 7:49 PM | Link | Comment!
  • Does Southern Europe Have A Central Bank?

    There has been quite a bit of happy talk in the media about the "resolution" of the eurozone crisis. I'm not clear why, since Europe's depression continues unabated. Real GDP peaked nine quarters ago, unemployment remains at 12%, and the debt ratios have not changed their trajectories. The ECB's own forecasts are grim. One is tempted to ask if the eurozone's real output will ever return to where it was in 2011, given its current slope. And even more disturbing, nominal GDP growth has been flirting with zero. The eurozone economy has flatlined, like a corpse. The crisis isn't resolved.

    But you wouldn't know this by listening to Draghi's press conferences. He is satisfied that the ECB has done all it can in terms of stimulus, and that recovery depends upon further structural reforms. He says that "low growth is the outcome of economies that need to have structural reforms", and that "structural reforms are the necessary and sufficient condition for recovery to happen". He reviews the dismal economic statistics (and the ECB's dismal forecasts) at his press conferences, and then concludes by congratulating the ECB for achieving price stability, its single mandate. The fact that inflation is running well below its 2% target is not a problem, since that demonstrates even greater price stability.

    By blaming the eurozone's depression on structural deficiencies, the ECB has washed its hands of Southern Europe: if the southern tier want growth, they will have to tighten their belts and wait for their domestic price level to fall until they become competitive. A few more years of austerity, and growth will naturally resume. As Irving Fisher said in 1933, "This is the so-called 'natural' way out of a depression, via needless and cruel bankruptcy, unemployment, and starvation."

    Barry Eichengreen*, an expert on the subject of the Great Depression, has accused the ECB's of having abandoned its core responsibilities as a central bank. In his view, structural reforms or the lack thereof are irrelevant and beyond the remit of a central bank, and cannot justify the abdication of a central bank's responsibilities as protector of the payments system, guardian of financial stability, and lender of last resort.

    Eichengreen lays out the devastating data: "The numbers are alarming. Core inflation fell to an annual rate of 0.8% in October - a 47-month low - while producer prices fell by 0.5%, suggesting that deflation is already in Europe's economic pipeline. Annual growth of M3 money supply, meanwhile, dropped to 1.4% in October, from an already dismal 2% in September, while loans to the private sector contracted by 2.9% year on year."

    He blames this state of affairs on the ECB's deference to German public opinion:

    "A responsible central bank should not cater to irrational fears of inflation in what is in fact a deflationary environment, just as it is not an independent central bank's role to tighten the thumbscrews for fiscal and structural reform."

    He deplores the ECB's decision to condition the performance of its core responsibilities on compliance with EU conditionality: "While a central bank should ensure the smooth operation of the payments and financial system, it makes no sense for this task to be contingent on governments' negotiation of a reform program with the European Union. The commitment to preserving the integrity of the payments system must be unconditional. If the ECB concludes that panicked investors are threatening the integrity of the payments system by selling a member state's bonds, then it should intervene, buying up those bonds on the secondary market, EU agreement or not."

    He is concerned that the ECB's focus on German opinion is leading to a deflationary spiral: "It is reasonable for the ECB to be concerned about its public standing. But if its leaders are worried about the impact on its reputation of embracing unconventional policy, they should pause and reflect on the much greater damage that would follow from allowing the economy to slip into a deflationary trap from which it would be difficult, if not impossible, to escape."

    Needless to say, the ECB does not agree with Eichengreen's diagnosis nor with his prescriptions. The ECB believes, instead, that its has been providing "extraordinarily accommodative" policy since the Crash, and that this policy is working. The ECB is also of the view that the preservation of the euro and the eurozone does not, will not, and cannot require the ECB to rescue individual countries or banks. They must save themselves by "bailing in" bondholders and uninsured depositors (in other words, default). That's the ECB's response to being asked to act as the lender of last resort.

    Eichengreen is worried that a eurozone deflationary spiral would be difficult to reverse. Europe only has two economic levers: monetary and fiscal policy. Ideally, these levers would be pulled in concert: the ECB would monetize fiscal deficits, thus increasing aggregate demand and inflation. But the ECB has forsworn both tools by demanding fiscal balance and prohibiting "monetary financing". Both levers are locked in the ECB's closet. If deflation does gather momentum, the ECB will have no tools to fight it.

    I have argued that, in the end, the authorities in developed countries will always choose financial stability when forced to do so by a crisis. I am beginning to think that this may not apply to the eurozone. The restoration of financial stability in a crisis requires the provision of unlimited liquidity by the central bank, and the support of a credible and responsible guarantor. When the US financial system was rescued five years ago, nobody worried that the Fed would withhold liquidity, or that the Treasury could not afford to recapitalize the banks. Everyone knew that the Fed had a printing press, and the US Treasury unlimited debt capacity. Once the TARP was up, the death spiral was stopped.

    The ECB is not acting as the central bank for troubled countries in Southern Europe; it is acting more like the IMF, a provider of conditional assistance. Further, there are no credible guarantors in the eurozone. Germany is too small, unwilling, and not responsible for the rest of the zone. The ESM is tiny. Thus Europe lacks an effective central bank and a credible guarantor. Indeed, we have already witnessed the collapse of the financial system of one of the Southern European countries, which occurred with the knowledge and approval of their so-called "central bank".

    Who will be next and what will happen to them? Under the Single Resolution Mechanism, depositors at all eurozone banks are at risk of default, conditioned on the financial resources of their governments. What stands between the next wave of insolvencies and financial collapse? Not the ECB.


    *Barry Eichengreen is Professor of Economics at UC Berkeley, and a former senior policy adviser at the International Monetary Fund. His most recent book is "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System". He has written extensively about the interwar gold standard. The piece from which I have quoted is "The ECB's Bridge Too Far", Project Syndicate, 10 Dec. 2013.

    Dec 16 7:33 PM | Link | Comment!
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