The Fed thinks it’s smarter than the markets

We’ll see . . .

PS. I have a post on low rates over at Econlog. The good news is that the post suggests that money’s not quite as tight as it might look based on bond yields. The bad news is that money is still too tight.

PPS.  Here’s a Paul Krugman tweet, discussing the Fed rate increases of 2017-18:

If you wonder what a negative fiscal multiplier caused by excessive monetary offset looks like, Krugman is describing it. I actually don’t quite agree, I believe the rate increases were appropriate, except perhaps the last one. But even in that case the main problem was bad forward guidance after the December 2018 meeting. Once that was corrected, things were OK. Until they weren’t.

In other words, on this particular fiscal stimulus issue I’m slightly more “Keynesian” than Krugman.

PPPS. As far as I can tell from the tweet thread, I pretty much agree with Krugman on the recession risk. Significant, but perhaps less than it looks.

PPPPS. America’s never had a soft landing, and (at least since WWII) we’ve never had a mini-recession. Other countries experience these sorts of events. Because we are in uncharted territory, with the longest expansion ever, we need to consider the possibility that one of these unusual events might occur.

(Trade) war, children, it’s just a tweet away

When I listen to the Rolling Stones, I often cannot understand the lyrics. But then the lyrics don’t matter, at least in terms of “information content”. All that matters is whether they sound good when Mick Jagger sings them. And they often sound very good.

When I listen to Trump, the information content often makes no sense. He’s going to pay off the entire national debt in 8 years? And he’s going to do so with tariff revenue? Well . . . that does sound good.

It sounds good when Trump announces that he’ll declare a trade war on big bad China, using higher tariffs. And it sounds even better when he reassures us that the tariffs won’t raise prices because they’ll be paid for by the Chinese. And it sounds even better when he announces that the tariffs will be delayed so that they won’t hurt our Christmas shoppers.

In a world where voters paid attention to information content, Trump might run into problems. But voters see no inconsistency here, because the tweets consistently sound good.

It looks like I was wrong in my earlier post about Trump’s tariff announcement signaling a desire to get an agreement.  Either he never intended that strategy, or China’s tough response made it impossible.  (Maybe the Chinese read my blog.)

Obviously if Trump is frightened of the political consequences of 10%, his previous threat of 25% on the consumer imports is completely off the table.  The Chinese called his bluff, and he backed off like a dog with its tail between its legs.

I must say that I am really enjoying seeing the US lose the trade war.  For years (even before Trump) we’ve been pushing other countries around.  It’s nice to see someone finally stand up to American bullies. That’s doesn’t mean I’m “pro-China” (whatever that means), as I hope the Chinese government loses its battle with pro-democracy forces in Hong Kong.  I’m pro-neoliberalism, which I’ll support any time and any place in the world.

Speaking of neoliberalism, this FT editorial is another sign of the decline and fall of Western Civilization:

It’s sad to see former neoliberal media outlets such as the FT and The Economist move in a statist direction.  A younger generation seems to have forgotten all the lessons of the final 3 decades of the 20th century.  I suppose some people would cite a quote attributed to Keynes:

When the facts change, I change my mind. What do you do, Sir?

So let’s consider the facts:

1. Market economies did better than statist economies before the Great Recession.

2.  Market economies did better than statist economies during the Great Recession.

3.  Market economies did better than statist economies after the Great recession.

In the same edition of the FT is another headline, a reminder of what statist policies do to an economy:

Argentine peso falls sharply for a second day

Turmoil continues to rock currency after strong showing by populist candidate in primary vote

I hope Tyler Cowen will hurry up and write his book entitled “The Great Forgetting.”

We’ve forgotten that monetary policy drives NGDP, and that fiscal policy is a fifth wheel.  We’ve forgotten that trade deficits are not a problem and budget deficits are.  We’ve forgotten that industrial policies don’t work.  We’ve forgotten that price, rent, and wage controls don’t work.  We’ve forgotten that saving is a virtue.  We’ve forgotten that low interest rates don’t mean money is easy.  We’ve forgotten how to build infrastructure. We’ve forgotten that nationalism is one of the great evils of world history.  We’ve forgotten that socialism is another of the great evils of world history.

Here’s Mick:

Oh, a storm is threat’ning

At least I think that’s what he said.

PS.  Brian asked me to talk about monetary policy.  Hey Fed, cut rates by 50 basis points.

HT:  Stephen Kirchner

Greg Ip asks an interesting question

David Beckworth linked to this tweet by Greg Ip:

1/ Random thought: maybe we could defeat lowflation by returning to the gold standard – at $3,000 per ounce.

There are some follow-up tweets. In the late 1990s, I wrote a long paper discussing FDR’s gold buying program, which was an attempt to create inflation by targeting gold at ever-higher prices.  (It’s a chapter in my Midas Paradox book.)  It turns out that this is a very interesting and very confusing issue.  But hey, it’s monetary policy, what else do you expect?

The simple answer to Greg’s question is “yes”, for the same reason that Japan could defeat lowflation by pegging the yen at 210 to the dollar, instead of the current 105/$.

To simplify things, let’s start with the “small country assumption”.  Lets say the Swiss saw this Greg Ip tweet, and were thinking about whether it could help them to achieve higher inflation.  From the Swiss perspective, it would be clear that this policy is basically equivalent to cutting the foreign exchange value of the SF in half, say from roughly one US dollar to roughly 50 cents.  Yes, that would create lots of Swiss inflation, no doubt about that.

[Here I am assuming that gold is currently $1500/oz., and that the Swiss action doesn’t impact the dollar price of gold—i.e. the small country assumption.  That’s why it’s effectively the same as currency depreciation.]

Could the Swiss successfully depreciate the SF?  Sure, if they offer to sell unlimited SF at the new target exchange rate, then that will become the new effective market exchange rate.  Are they willing to buy enough assets to make this new exchange rate stick?  This is the hard question.  It’s not even clear they’d have to buy any assets, as people might sell SF out of fear of imminent Swiss hyperinflation.

Obviously in the real world the Swiss would not want to depreciate the franc so sharply.  In that case they might have to buy a lot of assets to depreciate the franc.  And that might lead to worries about central bank balance sheet risk.  Now we are back to the longstanding debate about QE.  Not so much “does QE work”—a meaningless question—rather how much do you have to buy in order to assure that QE works?  As long time readers know, I don’t accept the standard view that more expansionary policy regimes require more QE.

The basic point is that pegging gold at $3000 will work, but the things you might need to do to make the peg stick could very well work even without bringing gold into the equation.  You could simply do all the QE without buying any gold.

If you were serious about doing something like this, wouldn’t it make more sense to peg the price of CPI futures contracts, not gold?  After all, we have a pretty good idea as to what sort of CPI futures price is likely to lead to roughly 2% inflation, but we have absolutely no idea as to what sort of gold price is likely to lead to 2% inflation.

If we go beyond the small country assumption, things get more complicated.  The US is so big that an attempt to peg gold prices at $3000/oz. could lead to a sizable increase in the global demand for gold.  In that case, the inflationary impact would be smaller than in the Swiss case, as the real value (i.e. purchasing power) of gold would rise.  Even so, it would still “work” in the sense or raising the price level, just a bit less dramatically.

These are not good policy ideas, but they actually are quite useful thought experiments.  They allow us to better understand the real issues at stake here.

PS.  If we were to return to the gold standard, presumably it would involve a gold price peg that increased by 2%/year.  That would give us the 2% long run trend inflation we seem to want, not the 0% long run trend under a true gold standard.

Does China have enough dollars?

Tyler Cowen linked to an interesting article on China’s financial situation:

The government’s dramatic about-face from encouraging aggressive overseas acquisitions to cracking down on risky lending and overseas transfers underscores worries over the risk that the nation could run short of enough US dollars to make the interest and principal payments on its mounting debt at a time when the current account balance is coming under pressure. . .

On the surface, China should be the last country to worry about a US dollar shortage given that its US$3.1 trillion worth of foreign exchange reserves is the largest help by any nation.

But analysts believe China’s reserves may be insufficient to pay for its massive imports and debt payments in response to a worse-case scenario caused by the ongoing trade war with the United States, particularly since many of its assets cannot readily be turned into cash to help the central bank to save a crashing financial system or sharp devaluation of the yuan’s exchange rate.

I don’t feel qualified to discuss the details of the article, but the overall thesis seems plausible.  Rather, I’d like to discuss two implications of this claim, which might not be obvious:

1. Previous accusations of Chinese currency manipulation were probably unfounded.

2. Contra Trump, monetary stimulus by the Fed would make it harder for the US to win the trade war.

The accusation that China engaged in currency manipulation during the 2000s and early 2010s (not recently–no one except Navarro believes they are doing it today) is based on the premise that China’s forex reserve accumulation was “excessive”.  If it was not excessive, if they don’t have enough reserves, then the entire currency manipulation claim collapses.

If the Fed engages in an expansionary policy that injects lots of dollars into the global economy, reflating nominal incomes, then debts become easier to service.  This helps the US somewhat, but probably helps China a lot.  It might make it easier for China to ride out the trade war without negotiating.  Trump should be careful what he wishes for.

Or perhaps Trump is playing 6 dimensional chess.  He knows that constantly berating the Fed will make them even more determined to look “independent”.  And he knows that global dollar deflation will put extreme stress on China’s finances.  Yeah, that must be what’s going on.

Party like it’s 1999

Unfortunately, the Cold War is not over. The US just pulled out of an arms control agreement with Russia. Russia is still an expansionist power that invades peaceful neighboring countries and takes their land. (Just as it invaded Poland in 1939.)

Russia is also the sort of incompetently ruled country that gave us Chernobyl. On the other hand, you might argue that this is all in the past. But is it? Here’s Bloomberg:

The failed missile test that ended in an explosion killing five atomic scientists last week on Russia’s White Sea involved a small nuclear power source, according to a top official at the institute where they worked.

The men “tragically died while testing a new special device,” Alexei Likhachev, the chief executive officer of state nuclear monopoly Rosatom, said at their funeral Monday . . . .

The blast was the latest in a series of deadly accidents that have damaged the Russian military’s reputation. Massive explosions earlier last week at a Siberian military depot killed one and injured 13, as well as forcing the evacuation of 16,500 people from their homes. In July, 14 sailors died in a fire aboard a nuclear-powered submarine in the Barents Sea in an incident on which officials initially refused to comment. A top naval official later said the men gave their lives preventing a “planetary catastrophe.”

Russia’s worst post-Soviet naval disaster also occurred in the Barents Sea, when 118 crew died on the Kursk nuclear submarine that sank after an explosion in August 2000.

Thanks for preventing a planetary catastrophe.

This time . . .

If there’s one silver lining to the planet going downhill fast, it’s that the media no longer obsesses about issues like Singapore banning chewing gum.  Now I long for the silly trivia of the 1990s.