The Central Banker Credibility War

Every weekend I turn to three sources of bearish information, having been fed to the gills all week long with bullish Wall Street candy.

My three favorite permabears are:

PrudentBear.com
SirChartsAlot.com
The-Privateer.com

This week, it's this July 8 article by Gary Dorsch at SirChartsAlot.com that got my attention.

He points out that stagflation is here, just as we all expected it would be.

He also notes that today's global game is one of central bank credibility, a game that the US, the UK, and a few others are losing.

Back in the early 1980's, Paul Volcker, the then Fed Chairman, took the stagflation bear by the paws and wrestled it down to the ground in spite of the bitter deflationary medicine it required the US economy to take.

Today, "Mr. Volcker warned US Treasury chief Henry Paulson, and Fed chief Ben Bernanke against letting inflationary expectations become embedded once again." Unfortunately, neither "Strong-Dollar (Ha-Ha)" Paulson nor Helicopter Ben is listening.

Another inflation hawk, the Bank of International Settlements chief Malcolm Knight, said on June 24 that “'[t]here must be a forceful response to confront the danger that inflation expectations could rise appreciably, with all the attendant problems that would bring.... With inflation a clear and present threat, and with real policy rates in most countries low by historical standards, a global bias towards monetary tightening would seem appropriate, even though economic growth is likely to be hit harder than most observers expect....'"

He too is talking to himself.

Dorsch continues:

"So far, the Fed and US Treasury have ignored Volcker’s [and Knight's] advice, and instead, are pegging the fed funds rate at -2.25% below the inflation rate, while inflating the MZM Money supply at a +16.5% annualized rate, a prescription for hyper-inflation. [Meanwhile,] the Fed’s aggressive rate cuts have failed to stop the bleeding...."

Why are they ignoring such good advice? Well, here's one explanation: Apparently some of our Fed governors just don't get it:

"San Francisco Fed chief Janet Yellen told her audience ... 'I see inflation expectations as reasonably well anchored. There is little monetary policy can do about rising commodities prices. If rising commodity prices reflect supply and demand fundamentals, then the situation is not likely to turn around any time soon.'”

But what a big IF that is, my dear. There is a distinct possibility that people like Anna Schwartz and Milton Friedman are right, and that "inflation [rising prices] is always and everywhere a monetary phenomenon."

After all, why would food and energy prices suddenly and violently increase if they were caused only by supply and demand?

The increase in global demand for food and energy and the resultant tightening of supply are two forces that have been on the increase over more than a decade now, and that have been squarely in the sights of suppliers worldwide for at least that long. Why the sudden upward move over the last year?

The only credible answer is that the market is finally waking up to the fact that, Yes Dorothy, inflation IS, always and everywhere, a monetary phenomenon, and Yes, Dear, it's coming back with a vengeance.

Unfortunately, what our US and a few other central bankers seem to be losing is the only thing they ever had to bank on--lacking as they do any scientific foundation--and this is their credibility; and this loss is being hedged against by at least two who seem to have the guts our bankers lack: the central bankers of China and Europe.

China's bankers warned the stock market public that they intended to act no matter what; and they did.

Likewise in Europe, "on Dec 19th, 2007, Trichet was asked on German television channel N-TV if the bigger danger to the Euro zone economy was the banking crisis or inflation? 'The response is very clear. We have a mandate. The primary goal is to preserve price stability. We are alert, and everybody must know that we will do whatever is needed, to deliver price stability in the medium term, and be credible in that delivery. The single needle in our compass is price stability,' Trichet said."

Fortunately for him, the European Central Bank mandate is straightforward price stability, unlike our dual mandate of price stability and steady employment in the US. (For further discussion on this point, see this article of mine, Page 1, Page 2, and Page 3 at the Los Angeles Business Journal.)

On the other hand, "the ECB’s anti-inflation crusade is thwarted by the other G-7 central banks [Japan, UK, US, Canada], which are afraid to raise their interest rates to combat speculators in commodities. Legions of 'yen carry' traders have migrated over from the global stock markets to the crude oil markets, since the rescue of Bear Stearns in mid-March [and since Dorsch's article was written, they seem to be moving elsewhere]. A continuation of the 'Commodity Super Cycle' to new high ground could trigger another ECB rate hike to 4.50% in the months ahead, putting enormous pressure on Bernanke to lift the fed funds rate to defend the dollar, or surrender the last ounce of the Fed’s credibility."

The question is becoming, Does Bernanke have the economic argumentation, the political mandate, and/or the plain-old cojones to begin raising rates?

We'll see Tuesday.

My bet is, they'll forgo it "this time"; and they'll jawbone about the lurking dangers of inflation just in case anyone's listening. But market ears are becoming deaf ears; and soon, without action by the Fed, inflation will take over in earnest. Then, someone in that Naked Emperors' Court will be obligated to do something.

(Until then, don't sell your gold.)

Jackson Hole: Saving Us From Themselves

'As Nathan Mayer Rothschild was fond of saying, “I care not what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man that controls Britain’s money supply controls the British Empire.” '

Interesting quote from this article at SeekingAlpha.com, by one of my favorite gold bugs, Gary Dorsch, blogger at sirchartsalot.com.

Gary's article points out some of the data you don't get from the dailies and makes my case look all the more scientific. (Gadflies can always use a little support.)

What I find the scariest element of our present quandary is that top economists, including 34 central bankers, are in complete opposition to each other on (1) the problem, and (2) the solution. Take a look at this article if you care to watch how our top-notch economic-scientist central bankers are scrambling for their next move.


[Thanks to thebestlinks.com for the image.]

Mishkin thinks that, due to positive "[r]apid financial change, triggered by innovation and deregulation", all this wonderful lending has simply "outstripped the available information sources"; and so he wants to lower the target rate. Feldstein of the NBER [National Bureau of Economic Research, the major supplier of much of the statistics available] sees the bad writing on the wall and agrees the Fed should lower it by 1 percent. Shiller decries a classic housing bubble and seems to want something to be done. Leamer warns about the coming recession. Fisher from Israel says do something about the bubble before it explodes.

Then you have Mayer flipping off everyone's worries, saying this whole housing-boom thing was simply a sign that it's now cheaper to own a home than to rent one. (Sure.) Others say that the bubble is simply an effect of monetary policy but not the cause of any recession. (Right.)

Bernanke himself walks the tightrope between one side and the other, saying the economy can handle this and maybe we'll do something, maybe we won't.

The consensus seems to be summed up this way: We'll have to "rely on judgment more than models." Okay. But whose judgment are you gonna pick? I admit there's a consensus that now is not the time to raise rates; but whether to lower or not (and/or pump more credit into the system), they're all over the charts but seem to be leaning towards easing/pumping.

I get the heebie-jeebies when I read that a year ago "the Bernanke Fed ... heavily inflate[d] the broad US M3 money supply, after it decided to hide the figures from the general public in March 2006. Since then, the US M3 money supply has expanded at a 13% annualized clip, up from 8% when the Bernanke Fed stopped reporting the key figure." (Look at the charts if you don't believe him.)

I thought they were holding money supply steady. Why would they increase it, when they've supposedly been combatting the inflationary pressure all this time?

And then I cringe again when I read this:

"[China] has been a net seller of US T-bonds for three straight months by a record amount of $14.7 billion, the longest period of sales by China since November 2000."

This is not the time for China to bail out on our T-bonds (although I don't think they really will, given the amount they hold.)

And this is an interesting quote:

' “At some point, you have to choose between trusting the natural stability of Gold, and the honesty and intelligence of members of the government. With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for Gold,” said George Bernard Shaw in 1928.'

GBS is not my paragon of economic virtue, but I like his occasional common sense and wit. I might just add that today the marketplace is more savvy and may have already factored in much of this wisdom. No one can really predict how things will play out. But we can take our chances....

And this:

'Should you place your faith in Federal Reserve notes? “Money is too important to be left to central bankers. You essentially have a group of unelected people who have enormous power to affect the economy. I’ve always been in favor of replacing the Fed with a laptop computer, to calculate the monetary base and expand it annually, through war, peace, feast and famine by a predictable 2%,” said Milton Friedman.'

He's another one whose gift of gab--indeed in his case genius of gab--got him places; but I note that he had the remarkable ability to say opposite things within the same paragraph. Here we have a committed devotee of small government saying both "power is bad" and "use the power anyway." Why not just be consistent and recommend we get rid of both the central bankers and the central bank (i.e. throw out the centralized computer, too)? Why can't we just let it all go and allow people to write contracts in gold? End of problem. (Perhaps an oversimiplification....)

Bernanke's job at the head of our monetary policy is an impossible one; but he wanted the job, so now he's got to at least pretend he can handle it. I don't envy him. The higher you fly, the harder you fall.

BIS Goes Austrian

Just a link for this one, to a great article at the Wall Street Journal, which I found at this site marginalrevolution.com.

Finally!!!!! Austrians may yet get the respect they deserve.

As to what the Fed should do, I have expressed my unsolicited opinion here and my fears here.