Federal Reserve: central bank policies have no effect
The Federal Reserve seems determined to deny the role they and President Bush has played in creating the hugh U.S. current account deficit. First it was Ben Bernanke who tried to blame it on a "global savings glut", something which I have commented here and here . Now Roger Ferguson has given a speech on the subject too. While both try to deflect the blame away from American policy makers and also say that the deficit is not really a problem, Ferguson's analysis is somewhat more "sophisticated" than Bernanke's, but in this context this is not really a good thing as it only means that his analysis is even more misleading.
Both Bernanke and Ferguson are saying that the explanation mostly or in part lies with a "savings glut" in Asia, Latin America and oil producing countries like Russia, Saudi Arabia and Norway. I do not in any way dispute that this is part of the explanation although I would prefer to call it "investment dearth" and would also say that it is less important than domestic U.S. factors.
Both Bernanke and Ferguson also acknowledge that the U.S. budget deficit has played some role in creating the current account deficit, but both also is quick to cite econometric studies claiming to prove that the effect is near trivial. It is difficult for me who do not have access to these studies to evaluate their validity, but I have a strong feeling that they are misleading.
What separates Ferguson from Bernanke is that he tries to 3 other possible explanations, namely a "autonomous" decline in private savings, increased productivity and "improved global financial intermediation".
His discussion of private savings is remarkable to say the least. He gives no explanation of the decline other than saying it is caused by some mystical X-factor holding down interest rates, pushing up asset values and expanding credit.
Hmmmm...., one would think that a member of the board of the Federal Reserve would not be unaware of which institution in American society who holds down interest rates. Apparently it is not a job requirement for Fed board members to be aware of the fact that they are the ones who set interest rates.
His discussion becomes even more bizarre later when he dismisses this as a factor because the decline in savings caused by low interest rates would generate high interest rates ! Again, he seems to be completely ignorant about what he normally does on his job, namely prevent interest rates from reacting to shifts in savings and investment.
His alternative explanations -which he with allegedly scientific econometric studies whose methodology and assumptions is not presented declares to be far more important than the budget deficit and the decline in private savings- namely higher productivity growth and improved financial intermediation which both allegedly have made the U.S. extremely attractive for investments fails a simple test of applicability to America's current situation.
If the deficit were really driven by foreign capital inflow, we would witness a rising value of the dollar in the foreign exchange markets. Simply put, if a deficit is driven by capital inflow the dollar will rise, but if the deficit is driven by excess domestic demand the dollar will decline.
And while the increase in the current account deficit in the late 1990s was indeed driven by the perceived higher returns of American assets reflecting itself in a rising value of the dollar and rising investments, the trend during the last few years has been the opposite with a falling dollar and lower investments implying that the deficit is driven by low savings in America rather than any willingness of foreigners to invest in America.
And moreover, the capital inflow that does come to America is to a large extent not driven by a perceived higher return but by foreign central banks wishing to prevent their currencies from rising in value. Until a few years ago foreign central bank purchases was at most a few tens of billions of dollars a year, but in 2004 it was $355 billion.
That someone like Roger Ferguson who not only is completely ignorant about basic facts about the U.S. economy but even seems ignorant about what he and his colleagues are doing at their job, is trusted to centrally plan the U.S. economy is quite unbelievable.
Comments (8)
Some of the most illuminating analysis I have read concerning the business cycle is Frank Shostak's explanation of the real pool of funding. This is what von Mises referred to as the subsistence fund--the accumulation of consumer goods used to sustain the production of producer goods.
Dr. Shostak explains that the US in the Thirties, and Japan in the Nineties (thru today) suffered a decline in the subsistence fund due to all the classic factors: persistent and rapid central bank inflating that spawned collossal malinvestment, the deterrent to saving of abnormally low interest rates, high and rising government spending,and high and rising regulatory burdens. Each factor reinforces the consumption of capital and aversion to saving that typifies the United States today.
In Japan, the end of its inflationary boom of the Seventies and Eighties created a big drop in stocks, real estate, and a general but mild fall in prices, despite frantic efforts by the BOJ to pump up the monetary base and stoke inflation. After years of pumping base money, the aggregate assets of banks in Japan are lower today than several years ago. The reason is that bad loans and repayment difficulties have inspired banks and borrowers to pull in their horns.
Loan repayment difficulties flow from the decline in the real pool of funding--the legagcy of big credit expansion combined with out-of-control government spending in Japan for twenty years. The depletion of the pool of funding causes the shrinkage of the capital base, which makes the provision for the future more difficult, and raises time preferences. As the BOJ madly pumps money, keeping interest rates near zero, the depletion continues, making it more difficult for people to lift themselves from this slump.
The United States may well be slipping into a similar difficulty, except that any downward spiral in our subsistence fund is presently mitigated by the blessing of the great inflow of goods from abroad. For now, Americans live partly off the prestige of the dollar as the world's reserve currency, which enables them to extract wealth from foreign producers, who are among the last to receive the newly created dollars.
However, when the willingness of foreign producers to maintain dollar balances diminishes, price relationships in the US will change, as producer good's replacement costs rise relative to the revenues those producer goods have been used to produce. Profits will get hard to earn and losses will become more common as the structure of production gets shortened. This will cause banks and borrowers to pull in their horns, even as the Fed pounds nominal interest rates into the pavement.
Perhaps the large expansion of the division of labor into Asia will buoy the US for several years, in spite of the capital-consumption that seems evident in the housing and derivatives booms, and in big federal spending. However, the idea, so prevalent among Austrians, that central bank inflating could never lead to deflation is a dangerous myth that one ought to guard against in the years ahead.
Published: April 27, 2005 1:33 PM
I think the Fed has the ability to effect the American economy but not the world economy. I think the world economy is tacitly controlled by the commodities and money markets.
Published: April 27, 2005 2:41 PM
I'm a little foggy on this point, so correct me if i'm out in left field, but Stefen Karlson's comment:
"If the deficit were really driven by foreign capital inflow, we would witness a rising value of the dollar in the foreign exchange markets. Simply put, if a deficit is driven by capital inflow the dollar will rise, but if the deficit is driven by excess domestic demand the dollar will decline."
isn't obvious to me.
My thinking is that supply of US dollars and demand to HOLD US dollars (in cash holdings) by the people of the world is what will dictate the dollar's value in the foreign exchange markets. Is it not this demand to hold the USD, rather than whether a US deficit is due to capital inflow, or excess US importation over exportation of consumption goods that dictates the exchange ratio?
The reason i think of it this way is that if we were on an international gold coin standard, we would not expect the value of US gold to fluctuate as a function of whether it's trade deficit was due to excessive imports over exports, versus capital inflows. Of course, all gold would remain equal in worth regardless of balances of trade.
Published: June 6, 2005 1:38 AM
Paul Edwards-the mechanism of the balance of payments is different in today's floating
exchange rate system than it would be under a gold standard (or for that matter, a fiat monetary union like the euro-zone).
In a floating exchange rate system, a increase in demand for say Japanese goods from Americans unmatched by a increased demand from the Japanese for either American goods or assets will result in a increased value of the yen versus the dollar. The reason for this is that when say Toyota receives all the dollars from their sold cars then they will have to sell their dollars to someone if they don't want to buy anything American. The people who are then buying the dollars sold by Toyota will then have to use it either to buy American goods&services. So here equilibrium will be achieved through exchange rate movements, not flow of money across borders.
Of course some dollars are literally exported, to countries which have completely dollarized their economies like El Salvador, Panama and Ecuador or where the dollar is seen as a better choice then the extremely highly inflationary domestic currencies. But this is a marginal phenonema in a wider perspective and is virtually non-existent for countries with inflation rates as low or lower then U.S. levels (Japan for example has long had far lower inflation than the U.S. , sometimes even deflation).
Under a gold standard, all countries are in effect in a currency union, with gold as the common currency. Under such a system there will of course be no exchange rate movements, any more then there are any "exchange rate movements"
between New York and Texas or "exchange rate movements" between IBM and Microsoft or between you and your supermarket, simply because you all use the same currency, the dollar.
Had America and Japan both been on the gold standard and the same scenario with increased sales of Toyotas unmatched by a increased willingness from Toyota to buy either American goods or assets then this will result in money flowing from America to Japan. Here then, equilibrium is reached through flows of money resulting in a higher money supply in Japan and a lower money supply in America (something which in turn is of course likely to cause price inflation in Japan and price deflation in America).
Published: June 6, 2005 3:28 AM
Thanks for the response, Stefan.
I would like to confirm that you are in agreement with my understanding of Mises when he emphasizes (according to my impression) the most significant and likely cause of a change in the price of foreign exchange is an increase in domestic inflation and not balance of trade. “Only if the Austrian Government embarks upon an inflationary policy and thus increases the number of schillings in the pockets of its citizens, are the Austrians in a position to continue to buy the quantities of Canadian wheat they used to buy without curtailing other expenditures.� The following quotes are from Human Action:
“People failed to realize that the rise in foreign exchange rates merely anticipates the movement of domestic commodity prices. They explained the boom in foreign exchange as an outcome of an unfavorable balance of payments. The demand for foreign exchange, they maintained, has been increased by deterioration of the balance of trade or of other items of the balance of payments…�
“The fallacies involved in this popular doctrine can easily be shown. If the nominal income of the domestic public had not been increased by the inflation, they would be forced to restrict their consumption either of imported or of domestic products. In the first case imports would drop and in the second case exports would increase. Thus the balance of trade would again be brought back to what the Mercantilists call a favorable state.�
“However urgent and vital an individual’s or a group of individuals’ demand for some goods may be, they can satisfy it on the market only by paying the market price. If an Austrian wants to buy Canadian wheat, he must pay the market price in Canadian dollars. He must procure these Canadian dollars by exporting goods either directly to Canada or to some other country. He does not increase the amount of Canadian dollars available by paying higher prices (in schillings, the Austrian domestic currency) for Canadian dollars. Moreover, he cannot afford to pay such higher prices (in schillings) for imported wheat if his income (in schillings) remains unchanged. Only if the Austrian Government embarks upon an inflationary policy and thus increases the number of schillings in the pockets of its citizens, are the Austrians in a position to continue to buy the quantities of Canadian wheat they used to buy without curtailing other expenditures. If there were no domestic inflation, any rise in the price of imported goods would result either in a drop in their consumption or in a restriction in the consumption of other goods. Thus the process of readjustment as described above would have come into motion.�
Published: June 6, 2005 2:13 PM
Yes that is correct. I liked your comment. I too belong to the same profile and this was of great help.
Andrea Jasperson
http://www.interestratescales.com
Published: February 8, 2006 4:37 AM
Present Fed policy CREATES inflation. Under the ruse of containing inflation, these bankers actually put upward pressure on the price of virtually everything produced by any company that carries short term financed debt! As debt is refinanced at higher rates companies must pass on the cost. Then the Fed claims their prediction was correct, but they haven't raised rates quickly enough to contain inflation and now must continue to raise rates! How self serving! It's a perpetual wealth creation scheme for big banks! Look back to 1978-80 when the Fed chased inflation, sure they finally "crippled" it when home mortgate rates hit 19%! Here we sit again at the precipice of "Stagflation" all thanks to the "Wise Council" of Bernanke's self serving crap! With these guys watching out for us, who needs Al Qaida?
Published: June 8, 2006 12:31 PM
THE FEDERAL RESERVE SHOULD BE ABOLISHED
In Article I, Section 8 of the U.S. Constitution, the people of the United States granted Congress the power "to coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” The people never gave congress the constitutional power to delegate this money-creating and regulating responsibility to any private group. Yet this is exactly what the Federal Reserve Act of 1913 did. The bill was publicly promoted as a plan to reform the nation's monetary system and stabilize the currency by taking control of it out of the hands of big bankers. In reality, of course, the Federal Reserve Act was written by the big bankers for the purpose of solidifying their control over our currency.
Many Americans today wrongfully believe that the Federal Reserve is somehow part of the federal government, possibly even the Treasury Department. Many do not know that the Federal Reserve is actually a cartel of private banks that was given the power to be the sole issuer of U.S. money, with full control over its quantity and thus its value. Since this group of private bankers (the Fed) provides credit to the U.S. government when we spend money we don’t have, the Fed also is able to profit handsomely from the ever-increasing national debt. Because the Fed makes more money when the country goes deeper into debt, there is no incentive for the Fed to support any reductions in federal deficit spending. The more credit we need, the more money this cartel of private banks will make.
The actions the Fed takes can drastically affect the economy simply by making decisions about the money supply and interest rates. The president, congress, big business, investors, home buyers and anyone else with an interest in our economy waits with baited breath every time the Federal Reserve Board meets. If they decide to raise interest rates, politicians and industries could fall, homes might not be purchased and jobs could be lost. If the Fed decides to lower the interest rates, politicians, industries, investors and consumers may prosper. There is too much power vested in a handful of people whose names would not be recognized by most Americans.
Why do we allow such a small group of people on the Federal Reserve Board to wield so much power over our country’s economic well-being? As average Americans strive to earn a living, cope with rising costs of food, fuel and hopefully save or invest for the future, Congress and the Federal Reserve Bank are working insidiously against them. On a daily basis, every dollar they have is being devalued.
Even though most Americans seem unaware of the current plight of the US dollar, especially in relation to the Euro, there is definitely a dollar crisis in the world economy because of the immense size of the international debt of America. America has now become the largest debtor in history, owing somewhere between $70 and $100 Trillion. The reckless deficit spending by our government, coupled with Federal Reserve currency devaluation, has become one of the greatest threats facing America today. Because Congress is routinely spending more than it can tax or borrow and the Fed is routinely printing “Fiat Money” (Dollars backed by nothing) out of thin air to make up the difference, this classic “one-two punch” threatens to further destroy the value of our dollars.
The actions of both major political parties would seem to indicate that they want the Fed to print more “Fiat Money” to support their extravagant and unchecked spending habits. Most politicians want the printing presses to run faster and faster, create more credit, issue rebate checks, etc., so that the economy will somehow be magically healed by this dangerous financial potion, or so they believe. The President and members of Congress may love a system that generates more and more money for their special interest projects and earmarks, but the rest of us have good reason to be concerned about our monetary system and the future value of our American dollars.
Issuing “Fiat Money” has allowed our government to live well beyond its means, but that practice cannot continue much longer as it is slowly destroying the value of our dollars. History shows us that when the destruction of monetary value becomes rampant, as the actions of our congress and the Fed would indicate, nearly everyone suffers and both the economic and political structure becomes unstable. The Federal Reserve System has been the tool used by the major bankers to allow them to gain control over the smaller regional and local banks. The Fed has also acted as the financing agency for Congress' unprecedented deficit spending on an ever growing, more intrusive federal bureaucracy and the expansion of the welfare state. Some people believe that the private bankers in the Federal Reserve wield so much power that they can intentionally manipulate the economy in order to influence the results of our presidential elections.
Our government and the American people do not need the help of any private banking cartel to manage our monetary system. We need to repeal the Federal Reserve Act and return control of our currency to Congress where it belongs, as was the intent of our Founders. We also need to have a serious national discussion about how real currency reform can be achieved. As long as the private bankers in the Federal Reserve have control over our nation's money, Congress' control of the purse-strings will not have the benefits the country’s Founders intended.
I support legislation introduced by Congressman Ron Paul, of Texas, entitled “Federal Reserve Board Abolition Act (H.R. 2755) that will restore financial stability to America's economy by abolishing the Federal Reserve.
REF: H.R. 2755: Federal Reserve Board Abolition Act
http://thomas.loc.gov/cgi-bin/query/z?c110:H.R.2755:
By:
JOHN W. WALLACE
Candidate for Congress
New York’s 20th Congressional District
www.FreedomCandidate.com
Published: March 16, 2008 4:32 PM