Sunday, July 29, 2012

Draghi Was Speaking Without German Authorization

Last week, Mario Draghi said that the ECB would do “whatever it takes” to save the euro, which was widely interpreted to mean that the ECB would intervene in the bond market to bring down Spanish and Italian bond yields. Following his statement, the Dow rose by over 500 points, reflecting the market’s expectation that the ECB will rescue the eurozone.

Readers will recall that I said to ignore anything Draghi says unless it is followed up by support from the German finance ministry (Schauble) and central bank (Weidmann). Now the evidence is in: Draghi was speaking without German authorization (see below).

Draghi’s statement has no information value unless it is predictive of future ECB policy, and I don’t see that we know anything more about ECB policy than we did before he spoke.

There will be no deus ex machina from the ECB until he can persuade Weidmann, Schauble, Merkel and the Constitutional Court (i.e., Germany) that this is both legal and desirable. That may still occur, but it hasn’t happened yet. Once this fact sinks in, I expect that the stock market's balloon will start leaking air.

I emphatically agree with Draghi that a rescue mission is required, but he is not in charge of the ECB and the markets need to absorb that fact.

Wolfgang Schauble, German finance minister:
(Seeking Alpha newswire, July 29)
German finmin Wolfgang Schaeuble rejected speculation that Spain is about to request that the eurozone's bailout fund [EFSF] buy its bonds. While the country's high interest rates are "painful," it is "not the end of the world if you have to pay a few percent more at a few bond auctions," Schaeuble told the Welt am Sonntag newspaper.

Deutsche Bundesbank:
(Reuters, July 27)
Germany's Bundesbank dampened expectations for further action by the European Central Bank on Friday by upholding its resistance to the ECB buying bonds, a day after ECB President Mario Draghi raised expectations such a move could be on the cards.

Draghi sent a strong signal to markets on Thursday that the ECB was preparing further policy action, saying that the ECB was ready, within its mandate, to do whatever it takes to preserve the euro, referring also to inflated borrowing costs, which some saw as a hint the bank could revive its bond purchase program.

The Bundesbank, which opposes the ECB's Securities Markets Program (SMP) because it treads too close to the central bank's ultimate taboo of state financing, said on Friday it was still not in favor of such a step. "The Bundesbank continues to view the SMP in a critical fashion," a Bundesbank spokesman said "The mechanism of bond purchases is problematic because it sets the wrong incentives."

ING economist Carsten Brzeski said Draghi's words were interpreted too enthusiastically, and he should have maybe been more careful. "Bundesbank comments are confirmation that this is not going to happen, that the ECB is not going to play Santa Claus."

Thursday, July 26, 2012

Eurozone: Ignore Whatever Mario Draghi Says

“Within our mandate the ECB is ready to do whatever it takes to preserve the euro and believe me: it will be enough.”
--Mario Draghi, July 26, 2012

So, is the eurozone crisis over? Do Draghi’s remarks today mean that the ECB has capitulated to the South, and will now buy Spanish and Italian bonds without limit until their yields come down? Is it time to sell bonds and jump back into the equity market with both feet?

In a word, no. We need to learn to stuff cotton into our ears whenever a non-German eurozone official is speaking. Unless you hear this kind of talk from Jens Weidmann, head of the Bundesbank, it is meaningless.

So far, we have had heard, in addition to Draghi,  officials from Austria, France, Italy, Spain and Belgium, statements endorsing an ECB rescue of the eurozone. We have heard no such statements from Finland, Holland or Germany.

Draghi may be one of the smartest people in Europe, but he is stuck in a no-win situation. If he does not act, the eurozone will blow up and he will lose his job. If he acts (with a working majority), Germany will go ballistic. He knows this, which is why his remarks* were so carefully crafted.

Draghi began with the bald statement above (“whatever it takes”) and then, later on, he walked back by saying “whatever it takes within our price stability mandate”. “Whatever it takes within the price stability mandate” is dramatically less than “whatever it takes”. He then goes on to list all the things that the ECB can’t do, such as lending to insolvent banks or buying bonds of non-compliant governments.

Basically, Draghi believes that he can lend to compliant governments and solvent banks in order to preserve the transmission mechanisms of monetary policy.

The fact that the North is doing well and the South is in a depression suggests that those transmission mechanisms no longer exist. Right now, Europe has two different eurozones, one where everything is working and one where nothing is working.

I will believe Draghi if and when (1) Weidmann says something similar; and (2) the ECB moves into the Spain/Italy bond market with overwhelming force and absolutely destroys the shorts (say, yields dropping below 4%). I do not expect either of these to occur, or at least not until we are closer to the edge of  gotterdammerung.

And furthermore, not only will the ECB not do whatever it takes, it will not even do whatever it takes within its mandate unless Germany agrees. Weidmann is very close to Merkel, so I believe that when he speaks, he is speaking for Germany.

The ECB governing council meets in one week. Between now and then, Weidmann or Schauble will say something relevant. Those remarks will be much more telling than anything Draghi says. Then, the ECB will have to craft its press release next Thursday. That will be the dispositive event. If it mentions yield-targeting for Spain and Italy, Draghi has won. If it doesn’t, Weidmann has won.

I am personally light equities and long Treasuries (TLT) and gold (GLD). If Weidmann wins, it’s bad for the world, but I will make some money. If Draghi wins, I am badly positioned. But I think I’m OK, at least for now.
*Draghi’s remarks:

Tuesday, July 24, 2012

The Wall Street Journal offers Spain some advice

The ECB shouldn't be acting as a crutch for ineffective national governments... Spain's crisis is Madrid's, not Frankfurt's, to resolve...Spain's political class is still goading Europe's central bank to do more. Without more labor-market reform and reductions in its swollen government, Spain will soon be back to Brussels with the begging bowl.

--WSJ editorial, July 24, 2012

The WSJ has been consistent in its support for hard money for over a century. As readers know, I am a soft money man right down to my toes. I wouldn’t blame the Journal for being consistently on the wrong side of history if they were just a voice in the wilderness. Unfortunately, a whole lot of important Republicans (and regional Fed presidents) believe that the Journal knows something about monetary policy, and parrot its quack nostrums and remedies as gospel. (These people worship Milton Friedman but have never read him.)

In my opinion, most of the world’s problems have been caused by hard money men and their camp-followers. Certainly every depression in world history has been caused by hard money. By hard money I mean deflationary policies caused by either inadequate money growth or, worse, a contraction in the money supply. Two classic (and self-inflicted) examples are: the deflation pursued by the US after the Greenback Era to resume gold convertibility at the prewar ratio; and the deflation pursued by the UK after the Great War to resume gold convertibility at the prewar rate. Both countries got the depressions their hard money men had desired.

Another of the world’s great self-inflicted depressions is happening right now, in the eurozone. In order for the southern members to stay on the euro, they are being forced to deflate just as much as if they were on the gold standard. Brussels’ tough-love prescription for them is to keep cutting spending until their expenses are as low as their ever-falling revenues. As their revenues decline, the more they have to cut. If revenue goes to zero, they will have to cut everything--but DO NOT PUSH THAT DEFAULT BUTTON! We’ll be sure to lend you just enough so that you don’t do that. Your people can starve in the streets, but don’t default. That would be disruptive and “bad for Europe” (cross yourself after saying that).

None of this would be happening if Europe had a responsible American-style central bank with a mandate to avoid depressions. If your mandate is to maximize employment, and some regions are experiencing up to 25% unemployment, you might be undershooting your employment target. And if your mandate is growth with moderate inflation, and your economy is in reverse and there is no inflation, you might want to touch the accelerator just a bit, rather than looking out the window and 
saying “I’m doing everything I can”.

No government in the world, no matter how "responsible" its policies, can engineer prosperity with an incompetent central bank. Right now all of the developed world’s major central banks are at best negligent. Their nonfeasance ranges from the catastrophic (BoJ, ECB), to the dangerous (UK), to the inadequate (US). And they are all pursuing hard money policies with low inflation and low growth. And they are all “doing everything that they can”.

So, in the opinion of the hard-money boys at the WSJ editorial board, Spain’s current depression is caused by inadequate “labor-market reform” and a “swollen government”.  Labor market reform won’t have any impact on Spain's debt-ratio arithmetic, and Spain’s government spending is declining at an annual rate of 5%. Not only isn’t its budget swollen, but cutting it further won’t make the slightest difference. Spain is running out of money, but not out of useless advice from Paul Gigot.

Spain is at a crossroads: it must either fix its central bank or get a new one.

Spain has a big deficit, billions of maturing debt into the horizon, no market access and an indifferent central bank. That is not sustainable, because she is running out of money (what economists call a "hard constraint"). Another handout by the Troika will be very costly, will add to Spain's debt, will annoy the German public,  and won’t solve anything. Spain’s money needs to come from a printing press. If the ECB stepped up and did its job, the crisis would be over and the Dow would go up by 3000 points. Otherwise, Spain will have to follow Greece with all that that implies for the world as we know it.

Monday, July 23, 2012

Greek exit will be another "Lehman moment"

“For me, a Greek exit has long since lost its horrors.”
--German economy minister Philipp Rosler,  July 22, 2012

So let me get this straight. Europe has been moving heaven and earth for the past two years to prevent a Greek exit. We were informed in hushed tones that a Greek exit would be a disaster for the eurozone. Trichet said that default by a eurozone government was impossible and “unimaginable”, and that such talk was irresponsible. We were told that anglosaxons didn’t understand “Europe”, that our arithmetic and pencilled debt ratios were irrelevant.

Now, the European wizards are telling us that a Greek exit/default/repudiation is not only thinkable, but not a big deal. “Nothing to see here folks, move along.” As a colleague at Moody’s used to say about managements in general: “No problem, no problem, Oops!, no problem.”

So don’t worry that, after spending billions to prevent an exit,  Europe is about to cut Greece loose. There will now be fewer but better eurozone governments; what Radio Tokyo used to call a “strategic consolidation of forces”.

My prediction is that Trichet was right all along: a Greek explosion  could be a disaster for the eurozone. First of all, Greece owes a lot of people a lot of money: the ECB, the EFSF, the IMF, the European banking system, and all of the hapless depositors in Greek banks. They will all be defaulted upon, with varying consequences. Just because we have all "known" that this would eventually happen doesn't mean that the world won't be thunderstruck when it does. A Greek exit will be a very big deal with a plethora of known unknowns and unknown unknowns. For example:

  • Will foreign governments freeze Greek banks’ assets and liabilities?
  • Who will be the receiver for Greek bank branches in London?
  • How will UK banks view their continental counterparties in Spain and Italy after a Greek redenomination?
  • How will Greece treat Greek citizens with euro deposits in foreign banks?
  • Will Greece close its borders and confiscate all euronotes?
  • What kind of exchange controls will Greece impose?
  • What will become of euronotes issued by the Bank of Greece? (Note: The identification code letter is Y.)
  • What will be the accounting treatment for frozen deposits in Greek banks?
  • How will Greek bank and government bonds be valued on banks’ books?
  • When Greek default rips a huge hole in the ECB’s balance sheet, will this require a recapitalization (which will annoy the German public)?
  • What will the Bundesbank’s balance sheet look like after Greece repudiates its TARGET2 liabilities?
  • How will the ECB treat the Bank of Greece and the Greek banking system after exit?
  • How will Greece pay for essential imports on Day Two?
  • If the Greek government loses control, will the army step in, as it did in 1967?
  • Will European governments have to intervene and purchase at par all Greek assets held by their banks?
  • How big a dollar swap line will be required by the ECB?
  • Can the looney-tunes in Congress prevent the Fed from lending to the ECB?
  • How soon before foreign creditors try to seize all Greek government assets outside of Greece?
  • When the Greek government and banks are declared in default under English law, what happens then?
  • Will European banks do business with Greek banks who are in default on deposits and bonds?

I’ve gotten tired of listing the known unknowns, but you get the idea. A Greek exit, if it occurs, will be a Black Swan as big as Lehman. It will be “the” event of 2012 (unless Spain goes too).

A Greek exit may have lost its horrors for Herr Rosler, but not for me.

Saturday, July 21, 2012

France rises above economics

He tells the French it is OK to love equality and social awareness more than success and money...
Hollande refuses to be made a prisoner of the constantly-invoked “harsh realities” of freewheeling capitalism, which are supposed to justify highly inegalitarian economic policies...
The French are wise to have elected a leader who makes his appeal to his countrymen’s republican social values rather than to their disappointed economic ambitions.
“Can the Socialists Fix France (and Maybe Europe)?”
Commonweal, 13 July 2012

You have to love the French Left. Their Marxist economics have always been hard and masculine and, above all, rigorously scientific. They have harnessed dry socialist theory to the practical management of a modern industrial economy. They write about “concrete” matters such as agricultural collectivism or the development of heavy industry, always in a scientific manner, and always without sentimentality or pity.

Those who would call attention to the rather unattractive human consequences of 20th century socialism would be accused of bourgeois sentimentality and false consciousness. The task of building socialism is not a tea party, and inevitably, many will suffer in the historical struggle.

But look at the French Left today. When confronted by a real economic crisis, one as simple as third-grade arithmetic, they disdain the “harsh realities” of capitalist economics and embrace the economics of “equality and social awareness”. In other words, when communists exterminate entire classes, that’s the cost of history. But when markets demand fiscal discipline, that is heartless. The French Left has gone from being the party of harsh reality to being the party of squishy sentimentality and wishful thinking. As ever, ideology triumphs over mere facts.

The Socialist Party now rules France. The people of France voted against the nominally capitalist party and voted Socialist, the party of equality and social welfare. This is the France that finances itself in foreign currency, has a big fiscal deficit, high debt ratios, high unemployment and almost no growth. High debt, big deficit, high unemployment, no growth: those are facts; they’re not negotiable; they cannot be “redefined”. France must either demonstrate to the bond market that she can stabilize her debt ratios, or she will eventually lose market access and default. What difference does it make that these facts are “harsh”? Can Hollande select a different set of facts?  

But France has rejected austerity, and intends to raise the minimum wage,  increase government spending, lower the retirement age, and build the socialist state, all paid for by levies on the “rich”. The more France spends on socialism, the more it plans to tax the rich. Those are "socialist values".

The harsh realities of capitalist economics may matter elsewhere, but not in France. Those laws have been suspended because the socialists have a vision that goes beyond mere economics.

I can think of one reason why the French don’t understand capitalist economics: because it isn't taught there. The academic discipline of postwar capitalist economics is anglosaxon, not French. In the anglosphere, we are taught about neoclassicism, Keynesianism, monetarism, the Chicago School, and the other attempts to explain the workings of a capitalist economy.

In a French university, "economics" consists of the socialist critique of  capitalist economics*. The postwar French intelligentsia studied, not growth or the business cycle, but how to combine the best parts of capitalism and communism (voila: socialism!). If you go to a bookstore in Paris, you will find thousands of heavy volumes on the defects of capitalism; you won't find one book that explains modern capitalist economics, except in translation.

When was the last time that a French economist won the Nobel prize? I can’t find any (unless you count expatriates). The Nobel prize in economics goes to the anglophone, not the francophone.

Today, the ruling political party in France is not capitalist, it is socialist. That’s not a blazing insight, but it might explain why France is distinctly uncomfortable with topics such as “competitiveness”, “real wage growth”, "structural rigidities", “debt ratios”, and “fiscal discipline”. Those are foreign terms that are used to impose the anglosaxon world-view onto France.

I remember when I was a bank analyst in the 1980s, trying to explain credit ratios to European banks. They would deny their applicability to Europe because  credit ratios are “American”. European banks couldn’t be understood using “American ratios”.

I see that today in France. There is a prevailing sentiment that capital markets are an alien concept and a part of the anglosaxon conspiracy. The markets are “harsh” and “unforgiving”, as if there were an another way for a country to borrow trillions of euros.

This much I do know: when France blows up, it will be blamed on capitalism, not socialism.

*If you think I exaggerate, read this:

Wednesday, July 18, 2012

Eighty years after Hoover, Republicans still cling to hard money

House Republicans pressed the Federal Reserve chairman, Ben S. Bernanke, on Wednesday to forswear additional actions to stimulate growth...

“The truth is, the Federal Reserve cannot rescue Americans from the consequences of failed economic and regulatory policies” the committee chairman, Representative Spencer Bachus of Alabama, said in his opening statement.

Other Republicans cautioned that an expansion of the Fed’s existing efforts could deepen the nation’s financial challenges by postponing a necessary reckoning and eventually accelerating the pace of inflation.
--NYT, 18 July 2012

The House GOP appears to have taken the position that further monetary expansion shouldn’t be pursued because it would postpone a “necessary reckoning”. In other words, weak growth and high unemployment are good because Americans need to be punished for Obama’s failed policies.

One suspects that the GOP is afraid that monetary expansion would spur growth and help the  Democrats on election day. That would be logical and understandable, since unemployment hurts Obama. I can accept short-term disingenuous politics. What I can’t accept is that the Republican House really believes that a day of economic reckoning is a desirable thing.

My concern is not that the Republicans will prevent the Fed from pursuing growth policies before the election; I want the Democrats to lose just as much as the next guy. My concern is that they are stupid enough to pursue hard money policies even after they get control of the government. I want limited government and prosperity. I don’t want another Hoover administration that would set back the cause of liberty for another eighty years. I shudder to think what nutcase could be the next Fed chairman if the hard-money boys get their way.

What the hard-money Republicans don’t understand is that their hard-hearted monetary policies result in soft-hearted liberal policies that only compound the economic damage. The Bush recession gave us ObamaCare; God knows what liberal panacea the Romney recession will give us.

It is remarkable that, after hard money wrecked the Republican party under Hoover, eighty years later the same economic nonsense still haunts the GOP. Williams Jennings Bryan must be looking down with a big smile on his face somewhere up there in Free Silver heaven.

Monday, July 16, 2012

Will Greece finally submit?

As someone who is not an admirer of European social democracy in any of its national costumes, I observe Greece’s financial spasms with clinical interest. For over two years, Greece has promised austerity in order to continue to get more handouts from the EU. Many repeated promises, but no actual public sector layoffs or social welfare cutbacks.

As we sit here, the Greek political class is searching for another way to convince the Troika to fork over more money without having to lay off one single state employee. They need the money really really bad right now, because their government revenue is spiralling downward. They can’t raise revenue and they can’t borrow, so they have to get paid right now as in, like, yesterday.  

The Troika, so far at least, has not blinked. They want to see parliament pass and the government implement the austerity legislation that they have so painstakingly dictated (see: “Germany plays with Greece”, Feb. 9th). Cut spending or no more handouts.

The Greeks do have leverage: "Give us the money or we will repudiate all of our debts". In the past, this threat has been successful. It may yet be again. But, as I say, so far the Troika hasn’t blinked. The longer the Troika doesn’t blink, the more desperate the Greeks will become because it appears that they are really about to run out of money.

They face an unpalatable choice: pass the legislation, lay off a lot of people and face riots; or, default, repudiate and redenominate. While redenomination will allow them to pay all of their employees and social dependents with Monopoly money, it won’t allow them to import anything unless it can be used to buy hard currency. That is a hard constraint.

The political class cannot imagine laying off state employees or cutting welfare programs, so they can only play games with the Troika. But it appears that they will soon have no choice but to obey the Troika’s diktat.

Sunday, July 15, 2012

Does Europe plan to end "Too Big To Fail"?

Officials from rich northern countries, led by Germany, have said that taking joint responsibility for bank rescues is possible only if recapitalizations don't create major losses—a strong case for putting a heavier burden on private investors.
The EU... in June proposed a new legal framework for dealing with failing banks...Crucially, the new rules would force national authorities to force losses on—or "bail in"—all creditors, for instance by converting debt into shares, when a bank has to be recapitalized by its governments.
WSJ, 15 July 2012

It would appear that the EU and/or the eurozone are drifting in the direction of removing the safety net from senior creditors and thus ending Too Big To Fail (TBTF). If the proposal becomes law, bank resolutions would impose losses on senior creditors. This means that, if regulators can write off senior debts without a court-supervised liquidation, then senior debt is neither senior nor debt, it is capital. Real debtholders have the right to demand a liquidation, with losses assessed against more junior claimants. If regulators can simply step in and treat senior bonds the same as other capital instruments, then senior bonds are capital instruments. When a bank can default on its senior debt, it is not TBTF.

This is another example of the eurozone expressing its unconscious death wish. Earlier, the zone experimented with the idea of allowing Greek government bondholders to take losses, which caused huge yield spikes for Spain and Italy from which they have not recovered. Now it proposes the same experiment with bank bondholders. Let’s see if it works better this time.

I do not see how, if this policy is adopted and rating agencies react, that this will not permanently close the debt markets to weak eurozone banks. Indeed, the bond market has already punished such dodgy names as Bankia and Caixabank in Spain, Unicredit and Monte dei Pasche in Italy, Dexia Credit Local in France, and HSH Nordbanken in Germany.

Ending TBTF would mean that the only remaining source of refinance for weak European banks would be the ECB.

One might have thought that the object of policy would be to (1) recapitalize all weak banks; and (2) draw a safety net around these banks, such that they would be viewed as creditworthy by creditors. It would appear that the current object of policy is to do too little too late about solvency, while signaling to creditors that they are at risk. Stop me if I’ve said this before, but these people have a deathwish.

Fiscal monetization and the shibboleth of central bank solvency

There is only one institution with the resources to save the eurozone, and that is the central bank. Only a central bank has unlimited resources in domestic currency. Yes, the ESM can be granted a banking license and then borrow without limit from the ECB if you are looking for a clever end-run around the ECB’s charter, but that’s a gimmick. Either way, it’s the ECB’s money.

The eurozone can be saved with the combination of 5-6% nominal growth plus yield-targeting for eurozone government bonds. The ECB can target 5-6% nominal growth by engaging in asset purchases until such a growth level is reached. This would allow most eurozone governments to balance their budgets (if they so choose). The ECB can also set yield ceilings for the bonds of compliant governments, such that their current level of indebtedness can be made sustainable and thus, et voila, no more crisis. Thus, all of the PIIGS except Greece could be saved. (Greece can’t be saved except by outright philanthropy.) As I have explained before, if yield-targeting results in excess money-creation, this can be sterilized by the issuance of “ECB bonds”.

The consequences of these two operations would be above-target inflation (which is desired) and a substantial decline in the asset-quality of the ECB’s balance sheet. The ECB would be directly exposed to the creditworthiness of its member governments, some of which are already below investment grade.

Let us assume that, by taking on these credit risks, the ECB’s solvency is threatened. Although central banks do not mark to market, they are exposed to delinquency and default, as well as outright repudiation, as will occur in Greece. This is, we are told, why the ECB cannot rescue the PIIGS: because it will endanger its solvency and “credibility”. Should the EU lose credibility, the euro will lose credibility as well. However, none of this is, in fact, true.

Many German commentators (and officials) have used the ECB’s solvency as a rationale  to oppose fiscal monetization.  This is always stated as a truism without a shred of evidence adduced in its favor.

Central bank solvency is meaningless. In granting the central bank the monopoly of the issuance of fiat (paper) money, the government has granted it a license of inestimable value, the license to print money. The value of this license is not capitalized on the central bank’s balance sheet. Like the value of the Coca-Cola brand, it is an uncapitalized intangible (not even footnoted). Thus, should a central bank happen to write down its assets by an amount greater than its capital, precisely nothing has happened because it can still print money. Does the Fed have a unit that performs the credit analysis of its principal foreign counterparts? No.

This would not be true, however, of central banks that make promises in commodities they cannot print, such as gold or foreign currency. Under those conditions, an analysis of their “cover” ratios is warranted. But if the bank is only printing its own liabilities, its resources are as irrelevant as they are unlimited.

Therefore, those who promote the falsehood that central bank solvency is necessary to the bank’s credibility, are using mythmaking to promote a different agenda. If the eurozone is to be saved, the ECB's solvency can be sacrificed without consequences.

Wednesday, July 11, 2012

The Fed's lame excuses for high unemployment

Below is my reaction to the release today of the minutes for last month’s FOMC meeting. Once again, they have an Orwellian (or Japanese) tone:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment...The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.  

First, Fed tradition requires the FOMC to bow to Mecca and intone that it “seeks to foster maximum employment”, in the same way that the city of Sverdlosk committed to meeting the goals of the 10th Party Congress, and the Archdioscese of Cincinatti seeks to promote greater holiness in the tri-county region. The words are cant, devoid of any practical meaning. A layman, uninitiated in the Fed’s secret rites, might imagine that a mandate to foster maximum employment would mean that the Fed would be obligated to target maximum employment, but he would be wrong.

Permit me to translate Fedspeak into English: “The Committee is in favor of maximum employment, thinks it’s an absolutely wonderful idea, and will keep doing the kind of things that it’s been doing which, it is hoped, will over an indefinite time horizon, increase employment”. The mandate is not to achieve full employment, but to bow humbly in its general direction.

Then, for the rest of the meeting, the FOMC engaged in a lot of hocus pocus about the yield curve, the low interest rate policy, swapping short paper for long paper, and worrying about whether low interests rates are hurting banks. Not once does anyone say “Gentlemen, we’ve been missing our employment mandate for almost four years; let’s talk about targeting our mandate”. That would produce an “awkward silence ensued” comment.

I do not mean to imply that Chairman Bernanke is not a good economist, or that he is unfamiliar with criticism such as mine. It’s not an intellectual failing; it’s a political one. When he was a Princeton professor, and even when he was a Fed governor, he was free to say similar things. But now that he is the pope, he has a different job: maintaining the Fed’s “institutional credibility”. This is analogous to Chief Justice Roberts’ job: to protect the institution and its authority.

Not only would targeting full employment require FOMC consensus, which isn’t there, but it would also require broad support from the economics profession and the relevant Congressional committees, such as the Monetary Policy subcommittee chaired by Ron Paul. So whatever Ben believes in the privacy of his own den, when he’s at work his job is to promote broad consensus both within and outside the Fed.

In 1933, there was near-unanimous consensus that the US needed to slash government spending in order to maintain the gold standard and the “credibility” of the United States. During his campaign, FDR said as much. But once he entered the Oval Office and saw the devastation being caused by deflation, he took the advice of some prairie college radicals and freed the dollar from gold, causing a sustained inflation (price-level targeting, as we call it today). He had so much power and authority at that moment, and things were so bad, that he could get away with something that would have gotten anyone else impeached.

The times today are not yet analogous, and Bernanke doesn’t have quite the authority that FDR had in 1933. But the issue remains the same: what are you targeting and how do you plan to get there?

The crucial distinction between manipulating inputs (interest rates, QE) and targeting outcomes is that the amount of input is not under discussion. When FDR decided to raise the price of gold, he had no idea what he was doing. Each morning he would arbitrarily set a new, higher price until he achieved his goal, which was higher commodity prices. He was targeting outcomes, not inputs. His more orthodox advisers were appalled.

The same policy should be pursued today. Since the Fed has conceded that the risk of inflation is very low, then it has no excuse not to target full employment. Better still, it should say so very loudly. The FOMC should announce that the Fed will engage in asset purchases until employment is restored to its 2007 level. Period. That is similar to what Bernanke repeatedly told the BoJ to do ten years ago.

But Ben will have to decide whether he is prepared to risk not only his own credibility, but that of the Fed itself. The Fed’s statutory independence is a creature of the government’s will. Given how many monetary nutcases there are now on the right, and given that the GOP might get full control of the government, he may decide that the Fed’s independence is more important than full employment. I could certainly understand that calculus.

I don’t mean to be cynical, but I would not be surprised if the GOP were to change its monetary tune were it to get control of the government in November (as happened to Nixon). I have been informed that, in his heart of hearts, Romney gets monetary policy. I certainly hope so.