Why can't central bankers so much as utter the word "money"...?
PROFESSOR TIM BESLEY, one of four academics chosen to set interest rates at the Bank of England in London (the other five policy-makers are career bureaucrats), gave a speech this week about "Inflation and the Global Economy".
For a central banker talking about commodity prices and the cost of living, he managed a remarkable feat.
He didn't use the word "money" once.
Nor did his BoE colleague Charles Bean when he spoke about the "prospects for the UK economy" on 17th April.
Nor did the deputy governor, John Gieve, when he spoke on "global imbalances" at the Sovereign Wealth Fund conference in London last month.
In fact, if you ignore the phrase "money market(s)", seven different members of the Bank's policy team used the word "money" just three times in nine speeches over the last ten weeks.
Their chosen topics included "policy dilemmas", "the return of the credit cycle", and even – on Wednesday this week – "Sterling and monetary policy".
But of money itself, the very thing the Old Lady issues and is charged with defending? It got three name-checks only.
The Federal Reserve seems to have Britney-sized "issues" with its core stock-in-trade, too. Issues verging on the neurotic, in fact. Allowing for one bizarre exception (in which Fred Mishkin claimed the Dollar's forex collapse won't create any Main Street inflation), some 23 speeches from five Fed policy-makers mentioned "money" a total of only eight times since mid-February.
Four of those mentions came in the phrase "money market(s)". And this from a team charged with providing a "flexible currency" – meaning money – to the citizens of the United States.
So why hide from the issue? Is the Fed scared of naming its very purpose? It no longer answers to Gold Bullion, depleting the nation's reserves every time it creates too much paper. And it can't surely fear a little ol' pile of bank-notes now, can it?
The Fed's Open Market Committee wields so much power, according to Robert Reich, former US secretary of labor, it should be classed the "fourth branch of government."
Forget about Congress, the White House, the courts, in fact; the Fed holds "more power over your daily life than your congressman and Senator, maybe even your president," Reich writes in his blog.
In short, the Federal Reserve "can do amazing things..." according to Reich, but it can't talk about money. Things like:
- "Decide one big bank, JP Morgan, is going to take over another, Bear Stearns, backed by $29 billion of taxpayer money...
- "Expose taxpayers to hundreds of billions of dollars of potential losses without a single appropriation hearing, as it did when it allowed Wall Street's major investment banks to exchange tainted mortgage-backed securities for nice clean loans from the Treasury...
- "Deciding the threat of recession is bigger than inflation, so it’s been lowering interest rates."
This last super-hero power, notes Reich – now professor of public policy at Berkeley –"has made the Dollar drop further and faster, which means you’re paying more for gas and food.
"Can you imagine if Congress caused this to happen?"
A cynic might add that Congress does plenty already to depress the Dollar as well. But if you can't imagine the public reaction to Congress actively destroying the currency, the Fed certainly can. It just needs to turn history upside down for a moment.
At the start of the 1980s, former chairman Paul Volcker was burnt in effigy by an angry crowd on the steps of the Capitol for hiking short-term interest rates to 19%. His policies aimed to quell inflation, of course, defending the value of Dollars.
Looking at Ben Bernanke's decisions today, you may wonder if he intends precisely the opposite. Slashing the cost of Dollars today also slashes their future-discounted value; Alan Greenspan's "emergency" response to the Tech-Stock Slump proves that today.
Volcker's infamous weekend announcement of sharp hikes in the cost of money – and therefore an increase in its future-discounted value – was a huge political gamble. Already sliding into recession, could the US bear such a high cost of borrowing? To judge just what was at stake, ask if America could bear it today.
To hold Uncle Sam's nose and get his strong medicine down, Volcker made plain he was in fact targeting not growth but "money" – meaning the quantity of credit and cash flowing through the economy. He was simply following the monetarist tactics of the German and Swiss central banks, stemming the flood of cheap credit and reducing the excess piled up during the 1970s.
As the value of each remaining Dollar bill stopped falling, so the cost of living would stop soaring. And at first, it worked like a charm.
Breaking out of the lecture theatre, the idea of whipping the money supply made sense to politicians and voters alike. It had first been put forward by the "Bullion School" of British economists at the start of the 19th century. Milton Friedman confirmed it with his "monetarist" theories of the 1950s.
The German Bundesbank and Swiss National Bank then applied it, successfully, to keep inflation at bay right through the late '70s. US and UK households, meantime – still stuck with the "tax and spend" policies put forward by John Maynard Keynes after the Great Depression – suffered double-digit growth in the cost of living each year.
Now in spring 2008, Zimbabwe offers the latest example of monetary inflation in action. Its people now own more money than ever before; what they lack is purchasing power. The cost of living is rising by 165,000% per year; the central bank is printing 10 million-dollar notes.
Here in the safe, developed West, the idea of targeting money itself – its supply and quantity – has lost out entirely since the late '80s to the idea of controlling its outcome, the cost of living, instead. The Bank of England, like the European Central Bank and US Fed, targets the Consumer Price Index each month, gazing into the future and trying to guess where inflation is heading.
"Indeed, the decline of [central bank] interest in money appeared to go hand in hand with success in maintaining low and stable inflation," as Mervyn King, now governor at the Bank of England, noted in a lecture first given at the University of Birmingham, England, in Oct. 2001.
King repeated his findings the following spring at the Banque de France in Paris. Pity that no one was listening. Not even him.
"Most people think economics is the study of money, but there is a paradox in the role of money in economic policy," he went. "As central banks became more and more focused on achieving price stability [in the '80s and '90s], less and less attention was paid to movements in money."
This Zen Buddhist approach to monetary policy – ignoring money so as to control, somehow...mystically...its inflationary outcome – was also noted by Prof. Glyn Davies in his History of Money (University of Wales, 2002). During "the overt acceptance of monetarist policies, inflation [was] far worse than when Keynesian policies prevailed," he writes.
"The average annual rate of inflation [was] in the twenty 'Keynesian' years after 1970 was around 2.4%, whereas that of the twenty 'monetarist' years after 1970 was, at 6.3%, well over double the previous rate."
Overlooking the money supply seemed the answer to delivering low, stable inflation in the last 20 years, too. Well, stable in a way that kept rioters off the streets and food protests off the evening news.
The US Dollar, along with the Pound Sterling, still lost half its value for consumers and savers between 1981 and today. But annual rates of inflation held below 3%, with occasional dips towards 1% growing ever-more frequent at the start of this decade. And all this while, with no one daring to mention it beyond a few cranks at the European Central Bank in Frankfurt, the supply of money worldwide has surged once again.
Over the last 12 months, the M3 measure of the money supply – a "broad" definition including notes, coins, bank deposits and short-term bills – has expanded by 16% in Australia. In Canada it grew by 13% and in the United Kingdom – where the M4 definition of "money" is slightly broader again – it grew by 12%.
China's M3 money supply grew 18%, Singapore's 14%, and in both India and Saudi Arabia it grew 22%. The United States stopped reporting such out-dated things in March of 2006, but its money-growth is credibly put at 15% over the last year. The Eurozone, stuck with a handful of old Bundesbank cranks, got a mere 11%, a three-decade record. By the start of '08, in fact, the 12-month growth in Europe's money reached almost three times above the ECB's original target of 1999, long-since forgotten as inflation held "stable", quietly nibbling into the value of savings.
Might this explosion in money matter again? Monetary theory doesn't help much, J.K.Galbraith once jibed, if you can't find people to make it work in practice. Put another way, "we didn’t abandon the monetary aggregates, they abandoned us," as the Bank of Canada's chief, Gerald Bouey, lamented in the late 1980s.
The Federal Reserve, for example, met no end of trouble in deciding which "M" to track and target. It started in 1978 with pretty much the simplest measure of money, M1 – meaning notes and coins in circulation plus instant-access (checking) bank accounts. But the Fed then felt the need to split it into M1A and M1B, making a distinction for cash-on-demand bank accounts, before then going back to M1 but with a new method for working out the cash total.
By 1986, even this new measure proved so volatile that the Fed gave up targeting M1 entirely, and switched instead to tracking M2 and M3 – broader definitions of "money" that include time-deposit and savings accounts, money market funds, and then short-term bonds. But these gradually broader definitions of "money" promptly stopped behaving themselves and also became wildly volatile.
What to do? "Hope springs eternal in the monetarist breast," smirks Glyn Davies in his History of Money, and the Fed team moved onto targeting a trend line in M2 growth, claiming that 3% per year would "eliminate inflation". When it didn't, they targeted 0% growth. And when the surging money-supply then failed to create anything like '70s-style inflation during the mid- to late-90s, the Fed quietly stopped targeting money altogether.
But on Mervyn King's analysis of 2001, speaking as though money does not count might yet cause trouble. The correlation between annual money-supply growth and rates of inflation, he found, reached 0.99 in the three-decade period ending in 1999. It would stand at 1.00 if they moved absolutely in lock-step. And King's conclusion – that "countries with faster growth rates of money experience higher inflation" – was already confirmed, he went on, by a 1995 study of 116 separate nations.
This research, however, was done long before King got top-dog position at the Bank of England. Since then, he's overseen (if not overlooked) double-digit growth in the UK's money supply, running now for a full 37 months.
"Habits of speech not only reflect habits of thinking, they influence them too," King went on in that long-ago speech about money. "So the way in which central banks talk about money is important.
"My own belief is that the absence of money in the standard models which economists use will cause problems in future...It would be unfortunate if the change in the way we talk led to the erroneous belief that we could turn Milton Friedman on his head, and think that ‘Inflation is always and everywhere a real phenomenon.’
"Money, I conjecture, will regain an important place in the conversation of economists," the current Bank of England chief concluded six years ago.
That day remains a long way off yet. Meaning there's plenty more room for mayhem in money ahead.