The Secret Subject of Money

“…Just like the Bank of England, the U.S. Fed seems to have Britney-sized ‘issues’ with its core stock-in-trade — money itself…”

PROFESSOR TIM BESLEY, one of the nine people chosen to set interest-rate policy at the Bank of England in London, gave a speech on Tuesday about “Inflation and the Global Economy.”

For a central banker talking about commodity prices and the cost of living, he managed a remarkable feat.

He didn’t use the word “money” once.

Nor did his BoE colleague Charles Bean when he spoke about the “prospects for the U.K. economy” on 17th April.

Nor did the deputy governor, John Gieve, when he spoke on “global imbalances” at the Sovereign Wealth Fund conference in London last month.

In fact, if you ignore the phrase “money market(s),” seven different members of the Bank’s policy team used the word “money” just three times in nine speeches over the last 10 weeks.

Their chosen topics included “policy dilemmas,” “the return of the credit cycle,” and even — on Wednesday this week — “Sterling and monetary policy.” But of money itself, the very thing the Old Lady issues? It got three name-checks only.

The Federal Reserve seems to have Britney-sized “issues” with its core stock-in-trade, too. Issues verging on the neurotic, in fact. Allowing for one bizarre exception (in which Fred Mishkin claimed that the Dollar’s forex collapse won’t create any Main Street inflation), some 23 speeches from five Fed policy-makers since mid-February mentioned “money” a total of only eight times. Four of those mentions came in the phrase “money market(s).”

And this from a team charged with providing a “flexible currency” — meaning money, of course — to the citizens of the United States. So why hide from the issue? Is the Fed scared of naming its very purpose? It can’t surely fear a pile of paper, can it?

The Fed’s Open Market Committee wields so much power, according to Robert Reich, former U.S. secretary of labor, it should be classed the “fourth branch of government.” Forget about Congress, the White House, the courts; the Fed holds “more power over your daily life than your congressman and senator, maybe even your president,” Reich writes in his blog.

In short, the Federal Reserve “can do amazing things…” according to Reich, but from our review of Fed speeches, it can’t talk about money. Things like:

  • “Decide one big bank, JP Morgan, is going to take over another, Bear Stearns, backed by $29 billion of taxpayer money…
  • “Expose taxpayers to hundreds of billions of dollars of potential losses without a single appropriation hearing, as it did when it allowed Wall Street’s major investment banks to exchange tainted mortgage-backed securities for nice clean loans from the Treasury…
  • “Deciding the threat of recession is bigger than inflation, so it’s been lowering interest rates.”

This last super-heroic ability, notes Reich — now professor of public policy at Berkeley — “has made the Dollar drop further and faster, which means you’re paying more for gas and food.

“Can you imagine if Congress caused this to happen?”

A cynic might add that Congress does plenty to depress the value of dollars as well. But if you can’t guess what would happen in Washington if Congress set out to destroy the currency, the Fed most likely can. It simply needs to turn history upside down for a moment.

At the start of the 1980s, former chairman Paul Volcker was burnt in effigy by an angry crowd on the steps of the Capitol for hiking short-term interest rates to 19 percent. His policies aimed to quell inflation, of course, defending the value of dollars. Looking at Ben Bernanke’s decisions today, you may wonder if he intends precisely the opposite.

Volcker’s infamous weekend announcement of sharp hikes in the cost of money — and therefore in its future discounted value — was a huge political gamble. Already sliding into recession, could the U.S. bear such a high cost of borrowing? To judge just what was at stake, ask if America could bear it today.

So to hold America’s nose and get his strong medicine down, Volcker made plain he was in fact looking to target not growth but “money” — meaning the quantity of credit and cash flowing through the economy. He was simply following the monetarist tactics of the German and Swiss central banks, stemming the flood of cheap credit and reducing the excess piled up during the 1970s.

As the value of each remaining dollar bill stopped falling, the cost of living would ease off. And at first, it worked like a charm.

Breaking out of the lecture theatre, the idea of whipping the money supply made sense to politicians and voters alike. It had first been put forward by the “Bullion School” of British economists at the start of the 19th century. Milton Friedman confirmed it with his “monetarist” theories of the 1950s. The German Bundesbank and Swiss National Bank then applied it — successfully — to keep inflation at bay right through the late ‘70s. U.S. and U.K. households, meantime, suffered double-digit growth in the cost of living each year.

Now in spring 2008, Zimbabwe offers the latest example of monetary inflation in action. There the cost of living is rising by 165,000 percent per year as the central bank prints 10 million-dollar notes. But here in the developed West’s inflation-free dream world, the idea of targeting money itself — its supply and quantity — has lost out entirely to the idea of controlling its outcome, the cost of living, instead.

“Most people think economics is the study of money, but there is a paradox in the role of money in economic policy,” as Mervyn King, now governor at the Bank of England, noted in a lecture first given at the University of Birmingham, England, in Oct. 2001.

King repeated his findings the following spring at the Banque de France in Paris. But not even he was listening.

“As central banks became more and more focused on achieving price stability [in the ‘80s and ‘90s], less and less attention was paid to movements in money,” he explained. “Indeed, the decline of interest in money appeared to go hand in hand with success in maintaining low and stable inflation.”

This Zen Buddhist approach to monetary policy — ignoring money and thereby controlling it — was also noted by Prof. Glyn Davies in his A History of Money (University of Wales, 2002). During “the overt acceptance of monetarist policies, inflation [was] far worse than when Keynesian policies prevailed.” Overlooking the money supply seems the answer to delivering low, stable inflation.

Well, stable in a way that nobody noticed. The U.S. Dollar, along with the Pound Sterling, still lost half its value for consumers and savers between 1981 and today. But annual rates of inflation held below three percent, with occasional dips towards one percent growing evermore frequent at the start of this decade.

And all this while, with no one daring to mention it beyond a few cranks at the European Central Bank in Frankfurt, the supply of money worldwide has surged once again.

Over the last 12 months, the money supply in Australia has expanded by 16 percent, in Canada by 13 percent and in the United Kingdom by 12 percent. China’s supply of money grew 18 percent, Singapore’s 14 percent, and in both India and Saudi Arabia it grew 22 percent.

The Eurozone, stuck with those old Bundesbank cranks, got a mere 11 percent surge in money supplies. The United States, which stopped reporting such outdated things in March of 2006, is estimated to have got a 15 percent expansion.

Might it matter? On Mervyn King’s analysis, yes. The correlation between annual money-supply growth and rates of inflation, he found, reaches 0.99 if you track the three-decade period ending in 1999. It would stand at 1.00 if they moved absolutely in lock-step.

But that research was done before King got top-dog position at the Bank of England. Since then, he’s overseen (and overlooked?) double-digit growth in the U.K.’s money supply, running now for a full 37 months.

“Habits of speech not only reflect habits of thinking, they influence them too,” King went on in that long-forgotten speech about money. “So the way in which central banks talk about money is important.

“My own belief is that the absence of money in the standard models which economists use will cause problems in future… It would be unfortunate if the change in the way we talk led to the erroneous belief that we could turn Milton Friedman on his head, and think that ‘Inflation is always and everywhere a real phenomenon.’

“Money, I conjecture, will regain an important place in the conversation of economists,” the current Bank of England chief concluded six years ago.

That day still remains a long way off yet. Meaning there’s plenty more room for mayhem in money ahead.

Adrian Ash
April 24, 2008