American Finance After Robert Morris
Robert Morris can be fairly said to have made the American Revolution possible.
Whither, Federal Reserve? (2)After Our Crash
Whither, Federal Reserve? (2)
The steepness of the federal interest rate curve -- ten-year treasury bonds pay more interest than three-month treasury bills, and the rate for intermediate time intervals slopes gradually from one to the other -- is a function of the Federal Reserve; the slope of this curve concisely describes current Fed policy. The Federal Reserve controls the money supply by raising or lowering short-term rates, which "affects the slope at the short end", and mainly in this way restrains or encourages inflation, or alters the exchange value of American currency. For the most part, long term rates are set by the public bond market. Once in a while, the Federal Reserve does buy or sell long-term treasury bonds to modify long-term rates in the economy. By affecting rates at either end, the result is some kind of change in the slope of the curve.
Because banks make interest payments to depositors near the short-term federal rate, while the same banks charge borrowers at near the public long-term rate, the current slope is the main determinant of bank profits. Banks borrow short and lend long. If Federal Reserve tinkering steepens the curve more than it would be without interference, then bank profits are subsidized. Of course, it works the other way as well; in a banking crisis, yield curves can be steepened to rescue banks from failure, thus potentially sacrificing ideal monetary levels temporarily. For the most part, what is good for the banks is good for the economy; but it remains that bank profits are subsidized much of the time. Artificially widened yield curves either punish savers by lowering interest rates on their savings accounts or else punish borrowers by increasing interest rates on mortgages and other credit. For political reasons, the pain is usually shared among voting blocs. It can be argued this invisible subsidy of banks by the public creates a compensating benefit of economic stability despite occasional bubbles and recessions like the present one. However, the Federal Reserve system has been in operation for almost a century, revealing a long-term bias in favor of inflation, which is a subsidy of debtors by creditors. Present policy deliberately targets a steady rate of 2-3% inflation; the gold market responded to a century of this by raising the price of gold from $17 to $900 an ounce. A 1913 penny has become a dollar (before taxes) you might say. You might also say it took the Federal Reserve less than a century to make the present dollar worth a penny.
If gradual inflation is a consequence, a fair question must arise whether the Federal Reserve is worth its cost. Compared with an inflexible, relentlessly deflationary Gold Standard, yes, it is. Even accepting the monetary crisis as partly created by central banking, the international dominance of the American economy and recent smoothing of banking instability testify to the durable use of the Fed. But another criticism must be faced: In subsidizing depository banks with an artificial yield curve, is the Fed backing the wrong horse for the future? To answer that question, examine two components: With computer technology rapidly advancing, can the Federal Reserve accommodate non-banking competitors to banks? And secondly, international central banking appropriately accommodate globalization? There are, after all, aspects within the 2007-20?? a crisis which suggests -- maybe it can't.
Steady inflation of 1000% per century may well be preferable to 19th Century volatility of 1000% every ten or so years. But a gradual rise of, say, 500% or less each century might be even better. Relentless political pressure on the Federal Reserve has typically been used to explain its slow retreat from truly stable prices, and this defense takes the form of mentioning its dual mission of minimizing unemployment while holding prices as steady as possible. In recent years, European political rhetoric goes further, aspiring to add the right to employment to their fifty-page Bill of Rights; similar utopianism has crept into our own news media. Governments for thousands of years have cheapened their currencies. But while the drift is clear, our own pace is set by the amount of subsidy required to maintain a steep yield curve. As retail banks have struggled to compete with the wholesale investment banks, their increasingly uncompetitive costs require a greater subsidy from the yield curve. It is always going to be more expensive to aggregate deposits for lending purposes than to raise large sums by floating a bond issue. Securitization is here to stay because retail banks have consolidated and savings banks have gone out of business by the thousands; the mortgage industry can no longer survive without substantial amounts of mortgage-backed securities. Nor should it; securitization is a sensible route for importing capital from nations with a trade surplus. Depository banks long ago lost the borrowing business of corporations large enough to float their own bonds; securitization provides a means for smaller borrowers to share the same efficiency. After it has tried everything else, Congress will eventually devise a reasonable regulatory system for derivatives. Except for smoothing the transition to whatever proportion of market share the investment banks can justify, perhaps all of it, the subsidized yield curve impairs efficiency. It would be a mistake to allow some foreign nation to exploit such an opening before we do. The technical problem for all central banks is to devise a suitable alternative method of controlling the currency, other than by targeting inflation with adjustments in interbank lending rates.
Observers led by Martin Wolfe the economist for the Financial Times feel the 2007-20?? financial crisis can be adequately explained by Chinese pegging their currency too low, and could be rectified by persuading the Chinese to float their currency. Regardless of this extreme view, globalization is clearly both a good thing and an inevitable one. Thus some form of discipline must be devised to prevent central banks from destabilizing it for their own advantage. Wolfe proposes the use of a strengthened International Monetary Fund, which is unfortunately apt to project international politics into a process which could be harmed by it. An alternative to be examined might be to pool sovereign wealth funds as a pooled currency reserve, although this system probably could not withstand present extremes between surplus and debtor nations, so getting world acceptance could be protracted. Ultimately, everyone realizes that the real backing for an international finance system is the net worth of the whole world. But the example of Lloyd's of London is a haunting one; no one relishes putting absolutely everything at risk, down to the last shoe button. In the event of a disaster, everyone wishes to hold back some nest egg to use for recovery. Because of the same line of thinking, almost no one would trust foreigners to control more than a limited share of their future.
The future of international monetary relations is thus quite murky, but current pressures would seem to be driving something fundamental to change. When it does, regulating artificially manipulated yield curves had better be kept in mind.
Originally published: Monday, May 18, 2009; most-recently modified: Sunday, July 21, 2019
|Posted by: Edith | May 12, 2013 6:20 AM|