2010 January 16 » New Jersey CFO

Otherwise-obscure central bankers spent an unprecedented amount of time in the global limelight last year. As the crisis brought down not only banking behemoths, but also macroeconomic axioms, the expansionary measures enacted by the Fed’s Ben Bernanke, the European Central Bank’s Jean-Claude Trichet, and the Bank of England’s Mervyn King have been credited, at least for now, with preventing a second coming of the Great Depression. And for that they have been hailed: Bernanke is both Time’s Person of the Year and Foreign Policy’s top global thinker, while Trichet wields tangible power in an otherwise diffuse EU and King has expressed ideas that are likely to influence future financial architecture more than those emanating from 10 Downing Street. But an epic battle unleashed last week between the Argentine government and its central bank is an apt reminder that the most challenging times for central bankers may lay not in the recent past, but in a more problematic future.

Argentina is usually singled out in textbooks as an example of what not to do with a country. Coup d’états and contradictory economic models have turned the fifth richest economy a century ago into the largest-ever sovereign debt defaulter in 2001. It is a tragic story. Since their accession to power in 2003, Néstor and Cristina Fernández de Kirchner, the country’s former and current president, respectively, seemed intent on changing Argentina’s direction post-default. Yet they soon revealed themselves to be another pair of messiahs turned into despots.

As in most developed nations, Argentina’s central bank is, by charter, independent of the country’s executive. The Harvard-educated, intellectually impressive current governor, Martín Redrado, has largely stood behind the Kirchners’ heterodox economic program, which favors export-driven growth as well as interventionist policies, including price controls and active resistance against peso revaluation. He was so supportive that in 2006 he provided central bank reserves to pay back all of Argentina’s outstanding debts with the IMF. As the country has remained largely cut off from capital markets since the default, paying back loans that accrued low single-digit interest (the IMF’s) while continuing to pay double-digit interest rates for “patriotic” bonds financed by their closest regional ally (none other than Venezuela’s Hugo Chávez) was clearly a political decision. For the Kirchners, hatred of the Washington Consensus weights more than the burden of interest.

In their second administration, however, the Kirchners’ authoritarian style has run them into trouble; in the midst of the global crisis, they sought to secure future sources of government spending in what became a true “asset grab.” First, they tried to radically increase taxes on agro-exports (rather sensationally, it was the government’s own vice-president who defeated the bill after a Senate tie). Then, in late 2008, the president pushed for the nationalization of all private pension funds, bringing an additional $25 billion under government control. Everyone saw it for what it was: a scramble for liquidity. Such moves have destroyed what was left of the ruling couple’s international reputation, and also much of their domestic political capital.

But it was only last week that the Kirchners’ hubris provoked a fully-fledged institutional crisis. Sidestepping an increasingly critical Parliament, the president took advantage of a legislative summer recess to issue a decree ordering Redrado to transfer $6.5 billion of bank reserves (around a quarter of the total, depending on the calculation) to the Treasury’s “Bicentennial Fund.” The purpose of such a euphemistically-baptized vehicle was to guarantee outright all 2010 foreign debt payments, in the hope that capital markets would welcome back the government and that fresh funds would revitalize the administration ahead of the 2011 presidential elections.

Reflecting changing political tides, however, Redrado refused to wire reserves to the Treasury, warning that they may be subject to confiscation abroad. After all, many of those bondholders hurt by the 2001 default have yet to settle their cases in international courts. But while the opposition attempted to convene an extraordinary parliamentary session to shoot down Kirchner’s decree, the administration doubled down: Through another decree, it fired the central bank governor. Hence they made a former key ally into a political martyr (and, odds are, a future paladin of the opposition).

How NOT to Manage a Central Bank Pierpaolo Barbieri

Google to defy China
Google announces an end to censored search results in China following alleged cyber attacks. Is Google.cn finished?

By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

A week ago, in Atlanta, Bernanke responded to his critics, including John Taylor of Taylor Rule fame (the Taylor Rule is a benchmark widely used by central banks in setting their “policy” interest rates). Bernanke asserted that monetary/interest policy has been appropriate-and was not” too low for too long” from 2001-2006. Taylor responded in a WSJ Op-Ed piece on January 11th reasserting his position that interest rates were “too low for too long”. A very public debate has been joined. Taylor’s view is based on his chosen variant of the Taylor Rule, while Bernanke cites his own chosen variant of the Taylor rule.

This post establishes that interest rates were “too low for too long” (from 1996-2006) while dispensing with the Taylor Rule and its sensitivity to choices of inputs and assumptions. It does so in a framework that employs definitions and measures favored by Bernanke. The frame work of the analysis is then used to answer other questions about economic policy in the past and going forward.

The Deflationary Threat?

Price stability/inflation targeting has been center stage of interest rate policy since Japan began its lost decades. Fear of deflation dominated the thinking of the Fed. This was especially evident in the response to the recession of 2001. The decidedly expansionary monetary policy adopted at the time was justified in terms of preventing a deflationary episode like Japan’s. In a February 2002 speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” Bernanke defined deflation as:

“Deflation is a general decline in prices, with emphasis on the word “general”.

Bernanke was drawing a distinction between changes in relative prices of some goods on the one hand and deflation – pervasive declines in prices – on the other. Later in the speech, Bernanke re-emphasized the point: “Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices register ongoing declines.” However, Bernanke and the Fed allow for exceptions. For example, food and energy inflation/deflation have been ignored even when changes in food and energy prices registered on broad-based indexes.

In the speech, Bernanke also specified the cause of deflation: “Deflation is in almost all cases a side effect of a collapse of aggregate demand –a drop in spending so severe that producers must cut prices…to find buyers.” In a footnote, Bernanke added:” I don’t know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case.”

Bernanke therefore defines a deflation as a generalized, broad-based, widespread decline in prices brought on by a severe drop in spending. The 425 bps of rate cuts in the Fed funds target during 2001 was presented as necessary to prevent a demand-lead deflationary spiral.

However, a simple decomposition of Bernanke’s favorite inflation measure, the PCE, for the bubble years 1996-2006 indicates that price declines were not broad-based, widespread, or “general”, but localized even as they introduced disinflation to the broad-based price indexes. Furthermore, there is evidence that demand by US-based economic agents did not drop below the level implied by full employment.
Chart (I) is of the PCE (and its components) price deflator(s). It clearly indicates that deflationary pressure was far from broad-based or generalized. The deflationary pressure was confined to the consumer durable goods component of PCE. The durable goods component had a weight between 12 to 13% during the period 2001-2006.

“Why Bernanke’s Defense of Super Low Interest Rates Does Not Hold

….the rulers of the exchange of mankind’s goods have failed, through their own stubbornness and their own incompetence, have admitted their failure, and abdicated. Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men.

True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish.

The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit.

Happiness lies not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort. The joy and moral stimulation of work no longer must be forgotten in the mad chase of evanescent profits. These dark days will be worth all they cost us if they teach us that our true destiny is not to be ministered unto but to minister to ourselves and to our fellow men.

Recognition of the falsity of material wealth as the standard of success goes hand in hand with the abandonment of the false belief that public office and high political position are to be valued only by the standards of pride of place and personal profit; and there must be an end to a conduct in banking and in business which too often has given to a sacred trust the likeness of callous and selfish wrongdoing.

FDR’s first inaugural address

Flagging: a US sailor stands on the flight deck of the aircraft carrier USS George Washington

If a week is a long time in politics, a decade is starting to look like an age in geopolitics. Comparing the America that began the 21st century with the America of today is to witness a country that has in some ways quite radically altered its view of itself and its relationship to the world.

In short, the metallic rust of decline has crept into the American soul. “You could argue that the first decade of the 21st century was the last decade of the American century,” says David Rothkopf, a former Clinton administration official and student of US foreign policy. “We are now entering the multipolar century.”

New Jersey CFO

Don’t cry for me….I’m NOT in Argintina

China now does what China wants to do – USA role reversal

Failure of Leadership

“Why Bernanke’s Defense of Super Low Interest Rates Does Not Hold

Analysis & Commentary