Monday, February 15, 2010

History may repeat 

In this paper we provide some evidence on when central banks have shifted from expansionary to contractionary monetary policy after a recession has ended--the exit strategy. We examine the relationship between the timing of changes in several instruments of monetary policy and the timing of changes of selected real macro aggregates and price level (inflation) variables across U.S. business cycles from 1920-2007. We find, based on historical narratives, descriptive evidence and econometric analysis, that in the 1920s and the 1950s the Fed would generally tighten when the price level turned up. By contrast, since 1960 the Fed has generally tightened when unemployment peaked and this tightening often occurred after inflation began to rise. The Fed is often too late to prevent inflation.
Michael Bordo and John Landon-Lane, in a new NBER working paper (ungated copy here.) Since September 23rd's FOMC statement the Fed has been emphasizing "resource utilization" and "resource slack", code for unemployment. Will prices turn north again before the Fed starts this new policy?

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Thursday, February 11, 2010

Bye-bye Fed funds target 

Any number of people seem to want Fed Chair Ben Bernanke to tell us when he will exit from the extraordinary monetary policy of the last two years. Yesterday in written testimony to Congress (he will appear when Congress gets over Snowmaggedon), Bernanke outlined a strategy, but didn't give a date for when he would execute it.

�Although at present the U.S. economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions by raising short-term interest rates and reducing the quantity of bank reserves outstanding,� he wrote.

�We have spent considerable effort in developing the tools we will need to remove policy accommodation, and we are fully confident that at the appropriate time we will be able to do so effectively.�

Mr. Bernanke, however, did provide new details of a major concern: how, as the recovery proceeds, to gradually shrink the balance sheet, which along with a vast array of assets also includes $1.1 trillion that banks are holding with the Fed.

Mr. Bernanke suggested that a new policy tool � the interest rate on excess reserves, which the Fed began paying in October 2008 � would be a vital part of the Fed�s strategy.

Increasing that interest rate, he said, will have the effect of pushing up other short-term interest rates, including the benchmark fed funds rate � the rate at which banks lend to each other overnight.

The text is here. In it Bernanke also suggests a new instrument for removing excess reserves from the system, a term deposit banks could make to the Fed that would compete with Treasuries as a store of liquidity for them.
The Federal Reserve would likely auction large blocks of such deposits, thus converting a portion of depository institutions' reserve balances into deposits that could not be used to meet their very short-term liquidity needs and could not be counted as reserves. A proposal describing a term deposit facility was recently published in the Federal Register, and we are currently analyzing the public comments that have been received. ... we expect to be able to conduct test transactions this spring and to have the facility available if necessary shortly thereafter. Reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so.
Both new instruments provide a means by which the Fed can increase its balance sheet without impacting the money supply, by inducing banks not to use their excess reserves for deposit expansion. I was familiar with both these instruments in Macedonia, where excess reserves were close to 30% of the money supply. The problem there was that it created flabby banks unwilling to lend, since easy government revenue was close at hand. The Fed does not directly spend taxpayer dollars, but its remission of excess earnings from its portfolio to the Treasury would be shifted to banks, and that indirectly expands the government's need for additional debt to cover its spending. That's not likely to go over well.

The biggest signal was not a date but a statement that the Federal funds rate would no longer be a policy instrument for the Fed, at least for awhile:
As a result of the very large volume of reserves in the banking system, the level of activity and liquidity in the federal funds market has declined considerably, raising the possibility that the federal funds rate could for a time become a less reliable indicator than usual of conditions in short-term money markets. Accordingly, the Federal Reserve is considering the utility, during the transition to a more normal policy configuration, of communicating the stance of policy in terms of another operating target, such as an alternative short-term interest rate. In particular, it is possible that the Federal Reserve could for a time use the interest rate paid on reserves, in combination with targets for reserve quantities, as a guide to its policy stance, while simultaneously monitoring a range of market rates. No decision has been made on this issue; we will be guided in part by the evolution of the federal funds market as policy accommodation is withdrawn. The Federal Reserve anticipates that it will eventually return to an operating framework with much lower reserve balances than at present and with the federal funds rate as the operating target for policy.
The last time the Fed abandoned the Fed funds target was October 1979, when then-Chair Paul Volcker thought it more prudent to stop inflation by using a target on reserves. That lasted perhaps three years, maybe less (see Alton Gilbert for more.) That period led to rather high volatility in interest rates may have contributed to the double-dip recessions in 1980-82.

It would be fair criticism of the above to say we really haven't used the Fed funds target for awhile and that this is just recognition of reality. But the FOMC statement still focused on it, and the Fed had not enunciated until yesterday what we might look at for an alternative target. Now we have. This will make reading the next FOMC statement on March 16 very interesting indeed.

UPDATE: John Taylor doesn't like the term deposits from the Fed to the banks.
In my view, Fed borrowing instruments should be avoided as much as possible because they delay essential adjustments in reserves and create precedents which make it easier to deviate from the monetary framework in the future. Similarly, the instrument of paying interest on reserves to achieve the short term interest rate target should be used only during a well defined transition period.
He argues instead for a rule that ties Fed fund rate increases to a decrease in reserves. It would make Fed policy more predictable.
[P]olicy makers could treat this exit rule as an exit guideline rather than a mechanical formula to be followed literally, much as a policy rule for the interest rate is treated as a guideline rather than mechanical formula. They would vote on how much to reduce reserves at each meeting along with the interest rate vote. Note that the exit rule would we working in tandem with a policy rule for the interest rate, such as the Taylor rule.
With all that's going on in Europe, this might be sliding under the radar. It shouldn't.

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Friday, January 22, 2010

Bernanke a victim of Brown-mania? 

(Sorry for late posting, but Friday is catch-up day and there was more than the usual amount to catch up.)

Hard to believe, but the Bernanke reconfirmation may be in serious trouble. Ed Morrissey fleshes out the story. The stock market sags partly in response. The WSJ Market Beat blog has a roundup of economists' reactions. A current tally shows 17 votes for reconfirmation, 12 against (including five Democrats), with five more Democrats answering that they are at this time undecided. Many of the Democrat opponents, including Barbara Boxer and Russ Feingold, announced their opposition today. Majority Leader Reid and Minority Leader McConnell are now jointly counting noses to see if they have 60 votes (as the more anti-Fed types like Jim Bunning are placing a hold on Bernanke's nomination.)

Opposition to the Fed chair seems to have increased since the election of Scott Brown on Tuesday. The Huffington Post reports this afternoon that

The election in Massachusetts has senators who previously considered themselves safe watching their backs, and they don't relish the prospect of a vote in favor of a man who failed to foresee the financial crisis and is closely associated with Wall Street.

A recent poll found that 47 percent of Americans think Bernanke cares more about Wall Street than Main Street, while only 20 percent think he works for Main Street. Independents, who swung heavily for Brown in Massachusetts, are even more opposed to Bernanke than Democrats or Republicans. Fifty percent of independents think he cares first about Wall Street; 15 percent think he prioritizes the needs of Main Street. That's a difficult vote in the face of an angry public.

If Bernanke is confirmed, he'll have to rely on the same coalition that moved the bailout through Congress, when the leadership of both parties joined forces to oppose the rank and file.

We get this rather unprincipled announcement from Sen. Boxer:

"I have a lot of respect for Federal Reserve Chairman Ben Bernanke. When the financial crisis hit in late 2008, he took some important steps to prevent what many economists believe could have been an even greater economic catastrophe," said Boxer.

"However, it is time for a change -- it is time for Main Street to have a champion at the Fed. Dr. Bernanke played a lead role in crafting the Bush administration's economic policies, which led to the current economic crisis. Our next Federal Reserve Chairman must represent a clean break from the failed policies of the past."

No, Senator, it is not the job of the Federal Reserve to be a champion for Main Street, Wall Street, or anyone else. The Federal Reserve is an independent institution, a feature that Congress chose wisely almost a century ago.

First, central bank independence has been shown to be essential for controlling inflation. Sooner or later, the Fed will have to scale back its current unprecedented monetary accommodation. When the Federal Reserve judges it time to begin tightening monetary conditions, it must be allowed to do so without interference. Second, lender of last resort decisions should not be politicized.

Finally, calls to alter the structure or personnel selection of the Federal Reserve System easily could backfire by raising inflation expectations and borrowing costs and dimming prospects for recovery. The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.

The Fed, as Robert Samuelson points out, has had officials testify before Congress 32 times. Its actions are not a secret, and attempts to find out who got direct loans from the Fed are more meant to intimidate than illuminate. The assault on its independence has helped push down stock prices and could set off a currency crisis in a G-7 currency, which is extraordinary. At a time where financial crisis still looms large in the rear view mirror, it is highly irresponsible to engage in scapegoating.

UPDATE: This tweet from Jim Geraghty got a hearty chuckle:

Overnight, every senator realized the quickest, easiest way to populist street cred is to treat Bernanke like he's the third Salahi.

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Monday, December 07, 2009

Mattress stuffers 

Demand for �50 notes has risen sharply during the recession because the public has lost faith in the banks, the Bank of England's chief cashier Andrew Bailey has suggested.

..."Two features of the current situation strike me as most relevant in explaining this development: first, lower levels of public confidence in the banking system and second, low interest rates," he said.
Source. That got me to wonder how much we are issuing in $100 bills here in the USA. Turns out the data is only annual, but we did issue $55 billion additional C-notes in 2008. As of November 23, there isn't much more in total currency issued -- no breakdown of the size of the notes there. Then again, when your economy contracts you would expect lower demand for currency, which makes the UK figures all the more surprising.

UPDATE: Paul Murphy suggests a third reason: worker remittances. But if anything remittances are down, not up in 2009. I have had several reports on lower remittances into Armenia this year, perhaps by more than a third from 2008.

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Wednesday, December 02, 2009

Kimfiscatory monetary reform 

North Korea takes a page from the later Gorbachev monetary policy playbook.
Chaos reportedly erupted in North Korea on Tuesday after the government of Kim Jong Il revalued the country's currency, sharply restricting the amount of old bills that could be traded for new and wiping out personal savings.

The revaluation and exchange limits triggered panic and anger, particularly among market traders with substantial hoards of old North Korean won -- much of which has apparently become worthless, according to news agency reports from South Korea and China and from groups with contacts in North Korea.

The currency move appeared to be part of a continuing government crackdown on private markets, which have become an essential part of the food-supply system in the chronically hungry North.

In recent years, some market traders have stashed away substantial amounts of cash, while establishing themselves in profitable businesses that the government struggles to control.

But under the rules of the new currency system, the wealth of these traders has largely disappeared, unless it is held in euros, dollars or Chinese yuan.

The revaluation replaces 1,000-won notes with 10-won notes but strictly limits the amount of old currency that can be exchanged, news reports said.

According to two Web-based groups with sources in the North, that limit was set Monday at 100,000 won, which at current black-market rates amounts to $40. All North Korean currency that individuals possess in excess of that amount becomes worthless under the revaluation.

Back in 1991, Mikhail Gorbachev confiscated old ruble notes in much the same way. Rather than make them worthless he forced citizens to deposit excess cash rubles into state-owned banks with the accounts frozen for five years. Hyperinflation in 1992-93 did the same work that Kim Jong-Il is doing to his citizens.

For many in poor countries like North Korea, banks are shunned because of a lack of transparency and poor service. People prefer to hold cash. It is not just speculators but average citizens who put their cash in safes, shoeboxes, mattresses, etc. To do this as winter sets in virtually assures that some small farmers, who will have converted crops to cash so they can buy food later, will now go hungry.

The confiscation of won will most likely stall inflation in North Korea. As the Soviet economy wound down additional rubles were printed to pay bills that could no longer be covered by a crumbling state industrial sector. It is less than a year from the confiscation to the end of the USSR. Not to predict that North Korea is going out of business soon, but this is certainly a sign of serious stress within the North Korean economy and political structure. To see what happened next, consider this account from Yuri Maltsev:
Everyone in the higher reaches of power had known for some time that a coup against Gorbachev [in the summer of 1991] would be a snap. One evening in Moscow, I discussed the possibility with a friend of mine, a general in the Soviet Army. He told me that an actual coup would be the easy part. "We could take power in ten minutes," he said. "But then what? We have no sausages, no bread � nothing to offer the people." The Moscow junta hoped its power grab would be bolstered by Gorbachev's low popularity. But as much as the people hated their ruler, they hated the coup leaders more. The coup government achieved only a short moment of glory. Once in power, it faced a people seething with anger at the crimes of totalitarianism and the poverty of socialism. The coup leaders also faced a hard winter, a very bad harvest, and the prospect of mass starvation. They lost their nerve, and Boris Yeltsin thwarted their efforts.
Does North Korea have a Yeltsin? I have no idea, but I'm going to be watching.

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Thursday, November 05, 2009

A million millions is a billion? a trillion? 

David Prychitko reminds us "there are a million millions in a trillion." True only if you use the short system of measuring large numbers. Those of us who collect old European paper monies are familiar with the words milliard and billiard. And even more confusing is this note, which has the B in the corner. The B represents a re-denomination of the pengo note. This one is from 1946 and was never released to the public. It would have been worth a trillion of the original wartime pengo. Of course this all happened due to Hungary's extreme hyperinflation. But that would be trillion in the long sense -- for those of us in America, it would have equaled 1 quintillion original pengos.

So I find myself wondering -- if America used the million, milliard, billion, billiard long form, would we view the current amount of spending in government with more trepidation or less?

Origins from Wiki

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Tuesday, August 25, 2009

Fewer secrets of the temple 

Last weekend on Final Word, I interviewed Vern McKinley, who has a Freedom of Information Act suit filed against the FDIC and the Federal Reserve for minutes of meetings in which decisions were taken on invoking emergency powers that permitted the Fed and FDIC to provide bailout funds to various financial institutions. Vern has posted his documents here, and Judicial Watch is now joined in the case as counsel for Vern.

Vern should therefore be encouraged by last night's ruling that the news agency Bloomberg will be given access to a list showing who received emergency loans from the Fed. The documents requested were to determine not only who got loans under the Fed's Primary Dealer Credit Facility but what kinds of collateral were pledged against the loans. The same was requested for three other facilities: the traditional Fed discount window, the Term Auction Facility and the Term Security Lending Facility. Just as in Vern's case, the Federal Reserve said FOIA has exceptions that permit them to deny Bloomberg's request. Separately, Bloomberg sought data on the Bear Stearns bailout, and the collateral pledged in that request to the Fed. Again, nothing. The court has ruled that the exceptions to FOIA that the Fed wished to use are not applicable to the information Bloomberg sought.

Vern rights that this ruling is "good news" for his case. Investigation of what happened in 2008 is vital; one hopes that the information will be useful in the upcoming reappointment hearings for Fed Chair Bernanke.

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Friday, August 21, 2009

Benanke: a U, not a V, and a me 

Ben Bernanke's speech at Jackson Hole, to me, was a yawner. The fellow who promotes transparency said absolutely nothing about the exit strategy he began to discuss in the Monetary Policy Report. Instead he gives Reflections on a Year of Crisis, the climax of which is a prediction that the turnaround of the economy will be slow:
Overall, the policy actions implemented in recent months have helped stabilize a number of key financial markets, both in the United States and abroad. Short-term funding markets are functioning more normally, corporate bond issuance has been strong, and activity in some previously moribund securitization markets has picked up. Stock prices have partially recovered, and U.S. mortgage rates have declined markedly since last fall. Critically, fears of financial collapse have receded substantially. After contracting sharply over the past year, economic activity appears to be leveling out, both in the United States and abroad, and the prospects for a return to growth in the near term appear good. Notwithstanding this noteworthy progress, critical challenges remain: Strains persist in many financial markets across the globe, financial institutions face significant additional losses, and many businesses and households continue to experience considerable difficulty gaining access to credit. Because of these and other factors, the economic recovery is likely to be relatively slow at first, with unemployment declining only gradually from high levels.
Up to the last two sentences it sounded like he was popping a cork. Arnold Kling is even more critical than I am. The role of Bernanke in the decisions on Bear, Lehman, and Merrill Lynch are not uniform, but Kling notes that Bernanke portrays the latter two as part of a grand strategy.
There [sic] word "panic" appears 14 times during the speech. The phrase "house prices" appears just twice, and the phrase "mortgage defaults" appears just once.

Clearly, Bernanke was listening to the CEO's of the big financial institutions who were telling him that they would have been fine if their short-term lenders had stuck by them. As far as the big bankers were concerned, this was an immaculate panic, in which their actual bad investments were not the problem. It was just that too many people lost confidence.

If this story is true, then whoever invested in banks and "toxic assets" last year should end up with a huge profit. The taxpayers should be raking in tens of billions, if not hundreds of billions, in windfall gains over the next few years, as the Fed and the Treasury cash in on the investments they made while everyone else was in panic.

But the market seemed to like it, with the Dow shooting up 1.5% in the first 90 minutes of trading. So the question to market participants is, what did you learn from this that you didn't know before? Is the U-shaped recovery a signal that the Fed will keep interest rates down long? What does that mean for inflation (gold is up $13 as I type this)? Why would Bernanke not reflect on the housing market where foreclosures continue to climb?

And before you pop a cork even on banks (what with the government deciding it doesn't need the last $250 billion of TARP), what about the 77 FDIC-closed institutions so far this year? Floyd Norris writes:
Although the losses on current failures stem mostly from construction loans, it is possible that commercial real estate will be the next big problem area. Losses in that area were growing at the Temecula bank, although its portfolio was relatively small.

During the credit boom, loans on those properties became easier and easier to get, on more and more liberal terms. Unlike residential mortgages, commercial real estate loans typically must be refinanced every few years. With rents and values down in many areas, that will not be possible for a lot of buildings, and some owners are just walking away from their buildings.

Two years ago, when the subprime mortgage problems began to surface, Washington took great comfort from solid balance sheets, which regulators thought meant the banks could easily weather the problem.

Last year, we learned that the regulators, like the bankers, did not comprehend the risks of some of the exotic instruments dreamed up by financial engineers. This year we are learning that the regulators, like the bankers, also failed to understand the risks of the generous loans that the banks were making in the middle of this decade.
I was on KNSI this morning, extending into Hot Talk when the Ox called in sick. Co-host Mike Landy asked me whether we have the right team in place to run whatever exit strategy we have. "We have smart people in the top places," I answered, "but these same people were there three years ago." I would like to see more learning and less cheering.

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Thursday, August 06, 2009

Lay down with dogs... 

...and it'll cost you a billion to get rid of the fleas.
Wall Street banks and lawyers could collect nearly $1 billion in fees from the Federal Reserve Bank of New York and American International Group Inc to help manage and break apart the insurer, The Wall Street Journal said on Wednesday, citing its own analysis.

Morgan Stanley could collect as much as $250 million, the newspaper said, citing banking experts and documents released by the New York Fed.

Bank of America Corp, private equity firm Blackstone Group LP, law firm Davis Polk & Wardwell LLP, accounting firm Ernst & Young, Goldman Sachs Group Inc and JPMorgan Chase & Co are among others that have or could get big paydays for helping dismantle AIG, the newspaper said.

You'll no doubt note the numerous TARP recipients on that list. But if the government owns 80% of a company and wants to break it up, it probably doesn't have its own mergers and acquisitions department. Nor should it. Still, it's one of those little surprises that will continue to haunt the government that decided to support AIG rather than let it fail.

To put it in context, market capitalization for the company is $3.18 billion. The government owns 80% of that, or $2.54 billion.

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Monday, August 03, 2009

The Fed Audit bill is about Congress taking over monetary policy 

In the debate over the Fed audit bill, one question I've had is what it is would be audited that isn't already. So I learned something today from Prof. Michael Woodford of Columbia.
It is important to remember that the GAO already has the authority to audit the Fed, and does, except that the bill giving the GAO this authority in 1978 specifically excluded certain aspects of the Fed�s activities from GAO audits � essentially, decisions about monetary policy. The only purpose of the new bill is therefore to decrease the Fed�s independence with regard to monetary policy decisions.
To verify that, I dug up a Congressional Research Service report from 2005:
The Federal Banking Agency Audit Act (P.L. 95-320) was enacted in 1978 to enhance congressional oversight responsibilities. The law gave the General Accounting Office (GAO; now the Government Accountability Office) the authority to audit the Board of Governors, the Reserve Banks and branches. Such audits are limited, however, as GAO is prohibited from auditing monetary policy operations, foreign transactions, and the FOMC operations. Congressional oversight on these matters is exercised through the requirement for reports and through semi-annual monetary policy hearings.
Here's the Fed's 2008 audits, and the last page shows the audits done by GAO.

Do you think the Congress should have the GAO audit monetary policy, rather than having this done in Humphrey-Hawkins testimony? Some conservatives do. Professor Woodford points out the dangers:
The dangers are especially great at a moment like the present one, when the prospect of large government deficits for years to come could easily make short-sighted decisions to use monetary policy to facilitate the financing of those deficits all too tempting. It is ironic that many of the proponents of reining in the Fed claim that their concern is preventing the Fed from further weakening the value of the currency, when the opposite would almost certainly be the consequence of their bill if passed.

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Monday, July 27, 2009

If California wanted to do this right 

Any time we see a financial crisis, it seems we get an experience with new, odd currencies. I wrote a few years ago about notgeld, the scrip issued by Austrian and a few German lander after WW I to pay for their goods when cash was tight. That could only be used to pay back debts to the government. Now it turns out California's IOUs are a new example. But Jesse Walker at Reason points to the lack of standardization as a reason why these notes lack a secondary market. This is creating a problem with discounting (to the extent banks even do it.) But you can't even return these bonds as an offset to taxes. You have to pay the tax in cash and wait to get your California cash redeemed for US currency in October. Thus California makes these IOUs less and less desirable.

Markets exist for everything, even CaliCash, but we know that increased liquidity will increase the price of any asset ceteris paribus. It would be better to issue scrip of standardized denomination, divisible, and useful in paying state or local taxes. Someone should get on the phone to the Governator and get this proposal to him. Or does he want to make them harder to accept?

Even cooler markets in everything: speculators offering to buy CaliCash on Craigslist. You'd probably get more from SecondMarket, but there are forms to fill out. So someone is willing to save you that time, it appears.

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Friday, July 03, 2009

Mrs. S writes 

...about the gold standard. I was surprised she decided to do this topic, and when she sent me a draft of it I was quite surprised how much she had learned.
But after World War I came the Great Depression. Country after country abandoned gold standard after the Depression. During World War II the allies held a meeting at Bretton Woods, N.H., to establish that the dollar was fixed to gold and everyone fixed to dollar. But that ended in 1971 because the United States didn�t want to play by those rules either.

I asked [St. John's economics professor Louis] Johnston if the gold standard made sense for today, and he argued that it would not. �Governments have no better sense of what a currency �ought� to be than anyone else, so there is no case to give a government a monopoly in this area. Let markets determine what the value of a currency will be.�

It turns out the value of our currency is not assured by government promising to convert money to gold. Instead, it depends on government doing those things that a gold standard would require. If we have the gold standard and no discipline, it fails. If we have the discipline, we don�t need a gold standard to tell us what our dollar will be worth 20 years from now.

Do we have that discipline now?

See also, as always, the Concise Encyclopedia of Economics.

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Wednesday, July 01, 2009

The Canadian job? 

Did someone pinch about 17,500 ounces of gold from the Canadian mint?
The Royal Canadian Mint is missing about C$18.8 million ($16.2 million) worth of gold and has not ruled out theft even as it continues to try to solve the mystery, according to an official on Tuesday.

An independent review by of the Mint's records found a discrepancy of 17,500 troy ounces of gold -- worth about C$18.8 million at current prices -- between the Mint's accounting and its physical count of precious metal done at the end of 2008.

The Mint refines 5.4 million troy ounces of gold a year, turning raw metal and scrap jewelry into 400-ounce bars.

The bars that the Mint makes out of scrap gold weigh about 27.5 pounds (12.5 kilos). It's a bit heavy to sneak out under a skirt or coat. And you'd have to take out 44 such bars for a theft that large. Mint officials say they had a lot of gold come in when prices rose above US$1000 an ounce. Hard to believe they'd end up with an explanation "we were swamped."

The mint's management has been told by government it will not get any bonuses until they find the gold. That should be reassuring. Wouldn't firing someone be the normal thing?

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Wednesday, June 24, 2009

Reading two FOMC statements 

This afternoon's versus the previous statement on April 29:
The inflation hawks can't be happy, and perhaps as much as the statement's disappointment for them will be the absence of a dissenting vote. The April meeting's minutes indicated some discussion of the balance sheet expansion and "contacts who had expressed concerns that the expansion of the Federal Reserve�s balance sheet might not be reversed in a sufficiently timely manner and hence that inflation could rise above rates consistent
with price stability." That discussion might have moved the last sentence as indicated in my last bullet point. But the Fed isn't moving as fast as some would like. �If there was a surprise, then maybe it was the fact that there was no mention of the exit strategy,� said one trader as stock and bond markets reacted badly.

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Thursday, June 18, 2009

Excellent fakes of fantasy bonds 

There's been bewilderment over the story from Italy where two Japanese "nationals" tried to smuggle in $134 billion in U.S. Treasury securities, including some Kennedy bonds of $1 billion denomination. �Now to my knowledge the largest denomination on a Treasury bond is $1 million. �Moreover, for these to be used in a transaction they would almost have to be bearer bonds, a bond that pays to whomever holds the bond, i.e., they're unregistered. �If I'm reading this document right, it appears there's only about $105 billion of those still in existence.

So it comes as no surprise to me that the bonds turn out to be fake.
�They�re clearly fakes,� said Stephen Meyerhardt, a spokesman for the U.S. Bureau of the Public Debt in Washington. �That�s beyond the fact that the face value is far beyond what�s out there.�

Italy�s financial police last week said they asked the U.S. Securities and Exchange Commission to authenticate the seized bonds, with a face value of more than $134 billion. Colonel Rodolfo Mecarelli of the Guardia di Finanza in Como, Italy, said the securities, seized in Chiasso, Italy, were probably forgeries.

Meyerhardt said Treasury records show an estimated $105.4 billion in bearer bonds have yet to be surrendered. Most matured more than five years ago, he said. The Treasury stopped issuing bearer bonds in 1982, Meyerhardt said.

Had the notes been genuine, the pair would have been the U.S. government�s fourth-biggest creditor, ahead of the U.K. with $128 billion of U.S. debt and just behind Russia, which is owed $138 billion.

According to the Italian authorities, the seized notes included 249 securities with a face value of $500 million each and 10 additional bonds with a value of more than $1 billion, as well as securities purported to be �Kennedy� bonds. Meyerhardt said no such securities exist.
I have looked for days for examples of a Kennedy bond but found none. So the questions become: who forged these bonds and towards what end? Who would have been willing to accept them as payment? How did these two persons come into possession of them, if they were not the forgers?

J.S. Kim also raises a good point here:
According to a brief Bloomberg article regarding this story, the seized bearer bonds allegedly were dated as of 1934. Since bearer bonds in denominations of $500 million did not exist in 1934, the bonds were deduced as fake, though the Italian police are still waiting for a declaration regarding the bonds� authenticity from the SEC. There is something truly �off� about this declaration. How can the quality of the forged bearer bonds be so meticulous that they �are indistinguishable from the real ones�, yet the people involved in the alleged forgery so ill-informed as to not date the bearer bonds with a more recent year that would not immediately identify them as fraudulent? How hard would it have been to date the bearer bonds with a more recent year? An equivalent analogy would be if an expert art forger meticulously re-created a Picasso oil canvas and then erroneously signed the work with the wrong artist�s name. This story just does not add up.
If it's a fraud, the best guess is that it's the North Koreans that have done this. �There are also stories that the $500 million notes are marked Federal Reserve Bonds from 1934, which is another type of bond that does not in fact exist. �These bonds may instead be something invented by a weird Asian cult (one of the two "nationals" appears to be Filipino.) �I suspect in the end it's much ado about nothing -- two cranks fly to Europe to pass off some excellent fakes of fantasy bonds.

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Monday, August 18, 2008

Adventures in numeraire choices 

In Zimbabwe, the new currency of choice as a medium of exchange (and soon as a unit of account?) will be gas coupons.

Bidders (at a car auction) must put down a deposit of 1,000 liters (220 gallons) of gas coupons, worth about $1,500 at the current gas price in Zimbabwe, and pay the rest in coupons when they pick up their purchases.

Zimbabweans face acute shortages of local currency. Already gas coupons can be used to pay some household accounts. Many businesses also pay workers part of their earnings in scarce foodstuffs, or demand dollars for purchases, which is illegal.

It's worth remembering that this currency shortage doesn't mean that there's not enough currency. Rather, there is so much money that nobody wants to use it. (cf. Hans Sennholz.)

From the same story, the removal of zeroes from the currency had as expected no effect, but

Obsolete coins also have been revalued, sending Zimbabweans hunting for coins they squirreled away in recent years.

Shops battled to count heaps of coins, causing long lines at checkout counters. One enterprising Harare business on Tuesday advertised coin weighing machines that even banks had discarded after coins went out of circulation in 2002.

Shopping and visits to cafes and restaurants became further confused this week by a range of different exchange rates used against the U.S. dollar.

On Wednesday, banks quoted the official exchange rate at about 10 new Zimbabwe dollars (1 billion old Zimbabwe dollars) to a single U.S. dollar. Businesses quoted an exchange rate in new dollars of between 25-1 and 100-1.

There is thus not only uncertainty about which currency gets used as the medium of exchange, but also what numeraire to use. At these levels, the output costs of hyperinflation must be huge.

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Friday, October 26, 2007

Nixon and Putin, sitting in a tree 

Controlling P-R-I-C-E.
Seeking to tame galloping food prices ahead of parliamentary elections in early December, the Russian government on Wednesday signed an agreement with major food producers instituting temporary price controls on basic products.

A tersely worded statement posted on the Web site of the Agriculture Ministry said the producers had signed the agreement �at their own initiative.�

�Producers and retail organizations, understanding the social responsibility of business in the balanced and stable development of the consumer market in Russia, will take necessary measures over the course of the agreement to ensure that the most vulnerable strata of the population can purchase products at acceptably stable prices,� the statement read.

Prices for products like cheese and vegetable oil have jumped and even doubled in some regions in the past two months.

Here's the Nixon period from Commanding Heights. Arthur Burns at the Fed raised the money supply 13% in that period in advance of Nixon's re-election. M2 in Russia at this time is up almost 28%.

A deep recession followed the relaxation of price controls in the US in 1974-75. Those investing in Russia are hereby warned.

(h/t: Greg Mankiw.)

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Thursday, October 25, 2007

Walking towards the target 

I realize that to some readers details of monetary policy are arcana. If you feel that way, go to the next topic; I'm going to work through this morning's report on the Federal Reserve's increased transparency proposal.

The discussion about Ben Bernanke since the minute after he was nominated to chair the Fed was whether and when the Fed would switch to an inflation targeting strategy for monetary policy. Today's report says the Fed is deferring that debate to a later time, and some might take from this that the inflation targeting is not in the cards. I read this report to say just the opposite.

The centerpiece of their new communications steps would be the release of economic forecasts of policy makers four times a year, instead of the current two times, with additional detail and background, according to people familiar with the matter. Moreover, the horizon for those forecasts would be extended to three years from two.

The new initiatives have been in the works all year. Earlier this year, the Fed had hoped to finalize them by this month. But the fallout of the market turmoil that erupted in August has complicated the agenda of next week's meeting of the policy-making Federal Open Market Committee and it may defer decisions on its communications policy to a later meeting.

Inflation targeting is really inflation forecast targeting. The central bank issues a report on what it thinks inflation will be over some time horizon. It then establishes a target inflation rate. The two put together inform one what the path of monetary policy would be. But they pretty much have to come in that order: A target without a forecast is a useless signal; a forecast tells you something even if you do not have a specific target in mind. I can think inflation should be higher or lower than the forecast without saying how much, though how much is something we would want to know.

Bernanke has been using forecasts more, elevating them in policy discussions. To have those now made public and more frequent is an important first step necessary for inflation targeting. It's not sufficient, though.

So what has to be discussed? This gets to the very heart of the Federal Reserve Act of 1913, the law that created and controls the behavior of the Fed. The Federal Reserve has a dual mandate to both maintain price stability and provide for high employment. Frederic Mishkin, in an interview just published by the Minneapolis Federal Reserve, discusses this compared to the European Central Bank, which has a mandate for price stability first. He says
The Congress has given us a dual mandate; that is, the Federal Reserve seeks to promote the two equal objectives of maximum employment and price stability, so that's what we have to execute. Even if the Congress hadn't given us such a mandate, the basic structure of the dual mandate is what I would feel is appropriate, and so we should be aiming to pursue such an objective anyway.

A hierarchical mandate says that first we focus on price stability and if we're successful then we'll focus on other concerns, particularly output fluctuations. If you interpret a hierarchical mandate as focusing on price stability in the long run, making sure that long-run inflation expectations are grounded�and we've seen tremendous success not just in the United States but in Europe in terms of grounding inflation expectations�then the dual mandate and the hierarchical mandate are identical.

Some people have said to me that the dual mandate versus hierarchical mandate dichotomy is a red herring. I don't agree, because I think it is an important issue in communications strategy. It's important to make it clear that you care about output fluctuations, but you're going to look at this from a long-run context and never take your eye off the inflation ball. That's the right way to do the dual mandate.

Similarly, with the hierarchical mandate, you should not be an �inflation-nutter,� as Bank of England Governor Mervyn King has expressed it. That is, you shouldn't be focused solely on inflation control. You must also worry about the fact that if you act too quickly to get inflation down to your long-run objective, you might have excessive, unnecessary fluctuations in output. So I think modern monetary theory, in writing down a hierarchical mandate or a dual mandate, will write exactly the same loss function, exactly the same kind of optimization theory for a central bank.
My suspicion is that this statement by Mishkin reflects Bernanke's view as well. (It's very unlikely that in a Fed publication a governor is going to say anything contrary to the view of the Board.) So the Fed may think it can accomplish the inflation target within the context of the dual mandate. But it has a second issue -- does it have complete goal independence to make this statement on its own, or will it need Congress to give some support? I turn to the means by which the Bank of Canada adopted inflation targeting, in which the Bank and the government made a joint statement in 1991. In both cases, the legislature can stop a proposal to create inflation targeting; in the Canadian case, the Bank was able to convince the government of its plan. (I'll point to this paper by Michael King for Canadian central banking history.)

It is interesting then that the Fed continues to refer to these changes as part of its communications strategy. Communicate with whom? I suspect communication is much towards Congress as it is with Wall Street. It needs at least tacit approval from both, in my view, to put inflation targeting on the front burner, and it may need legislation -- something to which both Congress and Wall Street will be loath. It should make for an interesting few years with Bernanke's Fed.

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Thursday, September 27, 2007

Small change or large beer 

When I worked in Ukraine it wasn't unusual for there to be problems with small change in retail transactions. Indeed, more than once I got a stick of gum for change in lieu of, say, 1000 karbovanets (would would have been $.006). I took the gum, never chewed it (I could only imagine what would be in my mouth), and never could pass it off as Krb 1000. I suspect I mostly threw them away. That's a loss.

Frank Stephenson today writes of a small currency problem in Guatemala that was due to government error. A friend of his in the country wrote:
Last year -nearing the Christmas season- the Banco de Guatemala (our central Bank) acknowledge to the embarrassment of it's authorities that it had run out of cash (due to bad planning, really). You can imagine that a large portion of Christmas sales in Guatemala are transacted in cash so the ineptitude of the central bank caused a mini-crisis specially in rural areas. The Banco de Guatemala did not acknowledge this but I know that they were purchasing Q20 bills for up to Q40 and Q50 (!!!). Somebody made a bundle out of this mess.
There was a period in Ukraine where the public phones needed coins that were worth maybe Krb 10 at a time where Krb 40,000 bought US $1. (Note: the karbovanets was Ukraine's temporary currency in the early 1990s, replaced by the hryvna in 1996.) The coins were worth far more for the metal than their exchange value, so they became scarce. But you needed them for calls, so babushkas would trade them at 15-20 times their face value. Some complained of this 'profiteering', so the government -- which owned the phone company still -- simply made public phones free. Result: babushki impoverished, and the phones soon neglected, broken and vandalized.

Tyler Cowen noted a few months ago that this phenomenon of small currency shortages is pretty common. Recommended therein is this book by Tom Sargent and Francois Velde, reviewed by Art Rolnick and Warren Weber at the Minneapolis Fed. But those stories apply mostly to token money (coins made of base metals worth much less than face value), not the paper currency Stephenson describes.

One thing I learned from gum money in Ukraine -- I used to try to buy beer on the street there (the local brand was Obolon', actually quite good in unpasteurized form if fresh), which came in both 0.33l and 0.5l bottles. I like the smaller bottles -- bring two home, one with dinner and one in the fridge for later, not too much for an evening. Alas, they are Krb 80,000 at the time and the seller didn't have change. (Gum and beer, not good.) The bigger ones? Miraculously, 100. Easier to buy those and just not finish the second ... though sometimes I did. Maybe more than sometimes...

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Thursday, September 20, 2007

Saber-rattling at central banks 

Greg Mankiw points out a press release by Rep. James Saxton that called for a Fed Funds rate cut of 25 basis points and says it's the last thing we need. Mark Thoma says "we should be very careful about compromising the Fed's ability to act independently of the rest of government."

The Milan conference was about this very point. So permit me to share a couple of thoughts. First, unlike the ECB, which has price stability as its sole objective , the Federal Reserve still operates under a dual mandate for both price stability and to promote economic growth. It is a creation of Congress. As John Wood presented at the conference, in the confirmation hearings for the renomination of William McChesney Martin in 1956, Senator Paul Douglas said:
I have had typed out this little sentence which is a quotation from you: �The Federal Reserve Board is an agency of Congress.� I will furnish you with scotch tape and ask you to place it on your mirror where you can see it as you shave each morning.
The Federal Reserve has some quasi-Constitutional status as an independent agency, but it is not above Congressional review. The degree of Congressional discretion has been long debated, but its protector is not a law; it's the bond market. (That point, by the way, is implicit in Alan Greenspan's direct-to-classic interview with Jon Stewart Tuesday night.)

This takes me to the second thought then, which is how independent SHOULD a central bank be. That is, given economic policy is something governments will do -- should they do any? take that question somewhere else please, no time for it here -- what is the optimal amount of delegation the government should give to a committee of experts? To get at that question (though it might not have been her intent) there was a presentation at the conference by Katrin Ullrich of the Centre for European Economic Research which posed the question of whether you would want to delegate fiscal policy at all. The reaction of the workshop was quite interesting; basically, you can't delegate fiscal policy because "taxing and spending the receipts of those taxes is what legislatures do." The reason we delegate the job of price stability to the sages like a Greenspan or a Trichet or a Bernanke is not just because they are smarter, more conservative (in the sense of more inflation-averse, not a political statement), but because monetary policy doesn't create winners and losers. But of course, unexpected inflation does, through the debtor-creditor hypothesis that most of my generation of economists had to learn in grad school.

Certainly on balance, economists have decided that countries where central banks are insulated from political pressure and have clear goals for policy do better in providing price stability. That's not the point -- it's whether elected officials can ever say anything about monetary policy. Most of the time what they say is self-serving blather. But if the optimal degree of delegation was 'complete' we'd all have the gold standard or a currency board and be done with it. Some economists may feel that's the right answer, but it isn't the majority. Every once in awhile, central bankers should look in the bathroom mirror.

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