From “57 varieties of tomatoes in Heinz ketchup”…to “exactly 57 communists in the Defense Department”

Reading Robert Samuelson´s piece in today´s WAPO – The curse of the dollar?-, where he refers to Fred Bergsten´s recent lecture on ‘currency wars’ where he says “there are at least 20 countries that can be classified as ‘currency manipulators’”, I was reminded of this great dialogue from The Manchurian Candidate (1962):

Sen. Iselin: I mean, the way you keep changing the figures on me all the time. It makes me look like some kind of a nut, like an idiot.”

Mrs. Iselin: Well, you’re going to look like an even bigger idiot if you don’t get in there and do exactly what you’re told…Who are they writing about all over this country and what are they saying? Are they saying: “Are there any Communists in the Defense Department?” No, of course not, they’re saying: “How many Communists are there in the Defense Department?” So just stop talking like an expert all of a sudden and get out there and say what you’re supposed to say.

Mrs. Iselin: Would it really make it easier for you if we settled on just one number?

Sen. Iselin: Yeah. Just one, real, simple number that’d be easy for me to remember.

[Mrs. Iselin watches Sen. Iselin pour Heinz Tomato Ketchup (with its “57 Varieties” slogan on its label) onto his dinner plate]

[Cut to Senate chamber]

Sen. Iselin: There are exactly 57 card-carrying members of the Communist Party in the Department of Defense at this time!

According to Samuelson/Bergsten:

It’s not just joblessness. Many Americans believe that foreigners have manipulated their currencies to enshrine their export advantage. In a recent lecture, economist Fred Bergsten of the Peterson Institute, relying on the work of his colleague Joe Gagnon, argued that at least 20 countries have regularly intervened in foreign exchange markets by buying dollars and euros “to keep those currencies overly strong and their own currencies weak, mainly to boost their international competitiveness and trade surpluses.”

There are too many things wrong with this kind of reasoning. In short, paraphrasing the now ‘famous’ “Don´t reason from a price change”, I would say “Don´t infer about a GDP component change”. It can easily lead one astray.

After FDR devalued the dollar in 1933 net exports dropped. In the last 10 months, although the yen depreciated by around 30%, the latest data show imports (‘surprisingly’) growing by more than double the growth in exports.

If the objective is to increase AD, that´s exactly the sort of result you can expect to get. The income effect trumps the relative price (terms of trade) effect. And given the weak level of world aggregate demand at present, so called ‘currency manipulation’ by many countries, the wrong label for ‘expansionary monetary policies’, is exactly what´s needed.

Maybe wanting to arrive at a round and easily remembered number like 20, Bergsten commits the ‘sacrilege’ of including ‘poor Denmark’ on the list. Obviously Denmark is not poor, only in the sense that it´s ‘contractually’ tied to the euro and so is ‘forced’ to buy and sell euros in order to keep the DKr/Euro rate constant (within a narrow band).

PS If I recall correctly, the term ‘currency manipulation’ was coined by the Brazilian Finance Minister back in 2010, and was directed at industrial economies in general and the US in particular, saying that the effect of QE was to appreciate developing countries’ currencies, reducing their competitiveness.


To me this is the best “wrap-up” of the R&R vs Krugman clash.

David Warsh´s “Footnote to a current controversy“:

The current dust-up between Paul Krugman and the “austerians,” in which the Princeton University economist, a columnist for The New York Times, cast Carmen Reinhart and Kenneth Rogoff, both of Harvard University, to play the villain opposite himself, is reminiscent of an earlier episode in the same drama.

In 1992 it was Krugman vs. the incoming Clinton White House.  Then it was Laura D’Andrea Tyson who played the heavy.

Bill Clinton had been elected and convened an all-star economics conference in Little Rock. Krugman was then being mentioned as a possible member of the Council of Economic Advisers. After Tyson, a University of California at Berkeley economist who had been a graduate student at the Massachusetts Institute of Technology just before Krugman arrived there, was chosen to chair the Council, Krugman went on Larry King Live and called the summit “useless.”

Over the next several weeks Krugman conducted a not-so-sotto-voce campaign against various appointments, especially Tyson’s. At one point he told Hobart Rowen of The Washington Post that Clinton “wouldn’t be able to get good economists to work for him.”  Rowen called the criticism “churlish.”


But as in the Little Rock case, he lacks a governor; or, in this situation, even an editor. The earlier episode ensured that Krugman would never again serve in government. (He had done a turn the CEA as a junior staffer under Martin Feldstein in the early 1980s.) This one surely clinches the case that he should never win a Pulitzer Prize. The habitual thumb on the scale has become contempt for the balance itself.

A theory is put to the test

Nomura´s Richard Koo of ‘Balance Sheet’ Recession’ fame is desperate that his theory is being put to the test and is losing ‘face’. According to Ambrose Evans-Pritchard:

As I reported last night, Mr Koo thinks the Abenomics plan of monetary reflation is madness. “Once inflation concerns start to emerge the BoJ will be unable to restrain a rise in yields no matter how many bonds it buys.” This could lead a “loss of faith in the Japanese government” and the “beginning of the end” for Japan’s economy.

He´s probably right with “beginning of the end for Japan´s economy”, if by that he means (which he doesn´t) that deflation will finally end and growth will pick up.

For too long monetary policy has been synonymous with interest rate policy. For example, at every round of QE Bernanke would say the objective was to drive down interest rates over the whole term structure. Curiously, the exact opposite happened as the chart illustrates.

Japan Reborn_1

The go-stop nature of QE reduces its effectiveness. The more recent ‘threshold contingent QE’ is a step in the right direction but, given the objects that make up the thresholds, has been causing ‘communication glitches’.

In Japan, given the more than two decades of low and sometimes even falling rates, the bond market took a little longer to ‘wise up. Yields fell for several months after Abe´s policy change announcement but for the past two weeks, following much better than expected growth news, they have soared as the market begins to realize that monetary stimulus designed to get rid of deflation has already managed to stimulate the economy.

As the charts show, the stock and foreign exchange markets were much quicker on ‘the draw’.

Japan Reborn_2

Japan Reborn_3

The big drop in the Nikkei on Thursday made headlines and some were quick to say “the end is near”.

Note, however, that after Abe´s election and up to May 22 (the day before the big drop), the volatility of stock prices had increased significantly. That usually happens during ‘state transitions’. Sometimes, doubts about the permanence of changes overwhelm market participants. It’s up to the PM and the BoJ to ‘stay the course’.

Japan Reborn_4

They could improve the situation enourmously if instead of having a 2% inflation target they announced an NGDP level target, as the following chart indicates.

Japan Reborn_5


Update: David Glasner explains the hightened sensitivity of markets in Japan:

[But] let’s just suppose that the Japanese, having experienced the positive effects of monetary expansion and an increased inflation target over the past six months, woke up on Black Thursday to news of Bernanke’s incoherent testimony to Congress suggesting that the Fed is looking for an excuse to withdraw from its own half-hearted attempts at monetary expansion. And perhaps — just perhaps — the Japanese were afraid that a reduced rate of monetary expansion in the US would make it more difficult for the Japan to continue its own program of monetary expansion, because a reduced rate of US monetary expansion, with no change in the rate of Japanese monetary expansion, would lead to US pressure on Japan to prevent further depreciation of the yen against the dollar, or even pressure to reverse the yen depreciation of the last six months. Well, if that’s the case, I would guess that the Japanese would view their ability to engage in monetary expansion as being constrained by the willingness of the US to tolerate yen depreciation, a willingness that in turn would depend on the stance of US monetary policy.

The highlighted segment in the paragraph above has correspondence to what happened in the early 1980s when the ‘US would not allow’ the yen to depreciate. And is also consistent with David Beckworths view of US supermonetary power status.

The more the ‘periphery’ becomes like Germany the more likely the Euro will brake-up

Michel Pettis has a very good, albeit too long, article: “Excess German savings, not thrift, caused the European crisis”.

A short segment:

But this was not all. If the savings that Germany exported into Spain could not be fully absorbed by the increase in Spanish investment, the only other way to balance was with a sharp fall in Spanish savings. There are two ways Spanish savings could have fallen. First, as the Spanish tradable goods sector lost out to German competition, Spanish unemployment could rise and so force down the Spanish savings rate (unemployed workers still must consume).

Second, Spain could have reduced household savings voluntarily by increasing consumption relative to income. Higher Spanish consumption would cause enough employment growth in the services and real estate sectors to make up for declining employment in the tradable goods sector.

Raising consumption

Not surprisingly, given the enormous optimism that accompanied the creation of the euro, the latter happened. As German money poured into Spain, helping ignite a stock and real estate boom, ordinary Spaniards began to feel wealthier than they ever had before, especially those who owned their own homes. Thanks to this apparent increase in wealth, they reduced the amount they saved out of current income, as households around the world always do when they feel wealthier. Together the reduction in Spanish savings and the increase in Spanish investment (in infrastructure and real estate) was enough to absorb the full extent of Germany’s export of excess savings.

But at what cost? The imbalance created within Europe by German policies to constrain consumption forced Spain into increasing consumption and boosting investment, much of the latter in wasted real estate projects (as happened in every one of the deficit countries that faced massive capital inflows). There are of course no shortage of moralizers who insist that greed was the driving factor and that Spain wasn’t forced into a consumption boom. “No one put a gun to their heads and forced them to buy flat-screen TVs”, they will say,

But this completely misses the point. Because Germany had to export its excess savings, Spain had no choice except to increase investment or to allow its savings to collapse, with the latter either in the form of a consumption boom or a surge in unemployment. No other option was possible.

To insist that the Spanish crisis is the consequence of venality, stupidity, greed, moral obtuseness and/or political short-sightedness, which has become the preferred explanation of moralizers across Europe begs the question as to why these unflattering qualities only manifested themselves after Spain joined the euro. Were the Spanish people notably more virtuous in the 20th century than in the 21st? It also begs the question as to why vice suddenly trumped virtue in every one of the countries that entered the euro with a history of relatively higher inflation, while those eastern European countries with a history of relatively higher inflation that did not join the euro managed to remain virtuous.

The European crisis, in other words, had almost nothing to do with thrifty Germans and spendthrift Spaniards. It had to do with policies aimed at boosting German employment, the secondary impact of which was to force up German national savings rates excessively. These excess savings had to be absorbed within Europe, and the subsequent imbalances were so large (because German’s savings imbalance was so large) that they led almost inevitably to the circumstances in which we are today.

For this reason the European crisis cannot be resolved except by forcing down the German savings rate. And not only must German savings rates drop, they must drop substantially, enough to give Germany a large current account deficit. This is the only way the rest of Europe can unwind the imbalances forced upon the region in a way that is least damaging to Europe as a whole. Only in this way can countries like Spain stay within the euro while bringing down unemployment.

A ‘map’ to help follow the argument:



Update: I thought the title to Scott´s post: “What´s good for Germany is good for the world” was misleading (probably because it´s ‘too blunt’). But it is certainly true that:

The real problem is that most countries don’t know what’s in their own interest. Greece doesn’t understand that it’s in Greece’s interest to privatize and deregulate.  Germany doesn’t know that faster NGDP growth in the eurozone is in Germany’s interest.

As the chart below shows, more NGDP in the eurozone is in Germany´s (and Spain´s) interest.

More NGDP in everyone´s interest


HT: Patricia Stefani

More on the “IT” Trap

It´s amazing how people of all persuasions are ‘stuck’ in inflation-thinking mode; if  a ‘low’ inflation target has been shown to be a ‘trap’, let´s make the target higher.

Three years ago this was what Blanchard suggested. The idea has returned through the pen of Laurence Ball:

A number of economists, such as Blanchard et al. (2010), have suggested a higher inflation target – typically 4%. Yet this idea is anathema to central bankers. According to Ben Bernanke (2010a), the Federal Open Market Committee unanimously opposes an increase in its inflation goal, which ‘would likely entail much greater costs than benefits’.

I examine the case for a 4% inflation target in a recent essay (Ball 2013) and reach the opposite conclusions to those of Chairman Bernanke:

  • A 4% target would ease the constraints on monetary policy arising from the zero bound on interest rates, with the result that economic downturns would be less severe.

  • This important benefit would come at minimal cost, because 4% inflation does not harm an economy significantly.

Interestingly, long ago there was the idea that a little more inflation would result in a (permanent) fall in unemployment. This was the Phillips Curve recipe embraced with excitement by the 1960s policymakers. We know what happened.

Now a little more inflation will protect the economy from falling into the “LT” or “ZLB”.

There´s always someone peddling the “miracle cures” provided by the inflation elixir!

As readers know very well, the MM solution to macro nominal stability (the full proof way to real stability) is to level target nominal spending (NGDP) along a stable growth path. Interest rates would lose their ‘instrument of policy’ status and become, together with a host of other asset prices, an ‘indicator variable’.

The ‘Inflation Targeting’ Trap

This is Simon-Wren Lewis concluding paragraph in a post on the “Liquidity Trap”:

What is missing is the link with inflation targeting. Because textbooks focus on the fiction of money supply targeting when giving their basic account of how monetary policy works, and then mention inflation targeting as a kind of add-on without relating it to the basic model, they fail to point out how a fixed inflation target cuts off this inflation expectations route to recovery. Quantitative Easing (QE) does not change this, because without higher inflation targets any increase in the money supply will not be allowed to be sustained enough to raise inflation. In this way inflation targeting institutionalises the failure of monetary policy that Friedman complained about in the 1930s. Where most of our textbooks fail is in making this clear.

This has forever been the market monetarists view on the dangers of inflation targeting regimes and how targeting the level of NGDP is much more ‘comforting’ and ‘productive’.

Bernanke´s greatest flop: A failure to communicate

“We hope the Fed is right that clearer communication can smooth the process of policy normalization, and we desperately hope they can deliver clarity in their communication soon.” Julia Coronado, BNP Paribas.

From the unfolding of market events in the last two days it is clear ‘clarity’ was conspicuously absent.

And Bernanke has been at it for so long. In January 2000 he wrote, with Mishkin and Posen:

Inflation targeting does not mandate that the central bank maintain the announced inflation target level at all times, come hell, high water or severe economic shocks. In fact, inflation-targeting central banks have found that they have more flexibility to respond to adverse events like financial crises and commodity price shocks. Since the central bank explains why it may have to miss the target and how it plans to get back on track, inflation helps maintain confidence in the commitment to price stability even when adverse developments lead to missed targets.

In 2008 he persistently rejected making use of the ‘theoretical’ flexibility.

Adoption of inflation targeting by the Federal Reserve would bring several major advantages over the current, less structured approach. First, it would transform the commitment to price stability—which has served us so well under Mr. Greenspan and his predecessor, Paul Volcker—from a personal preference of the chairman into an official policy. By depersonalizing and institutionalizing the Greenspan policy approach, the Fed would increase the likelihood that future U.S. monetary policy will look like the 1980s and 1990s rather than the 1930s or the 1970s.

It ended up looking like the 1930s

Third, increased transparency would diminish financial and economic uncertainty. More information from the Fed about its plans and expectations would reduce the perpetual, and wasteful, attempts by financial market participants to guess what the Fed will do next. An inflation target would also make it easier for businesses and consumers to plan.

Apparently financial and economic uncertainty has increased! Greenspan´s ‘mutterings’ were more easily interpreted!

The word that caused havoc: “Taper”. While in his prepared comment he warned against “premature tightening” (sending markets up) in the Q&A he said that he Fed might “taper” in the next few meetings…(sending markets down).

Although formally “taper” means “reduction” (in asset purchases), the market´s interpretation was “policy will tighten”. Less “easy” policy means in this day and age “tighter” policy.

Upshot: he was careless in his choice of words, conveying a negative image.

It´s midnight over here and noon in Japan. The Nikkei is up close to 3% but I have no idea what I´ll see when I wake up.

Stocks & Inflation Expectations: An update

In his latest evaluation of David Glasner´s inflation expectations stock price correlation, jp of Capital Spectator finds that recently the correlation has ‘disappeared’. His third explanation is:

The third possibility is that the new abnormal is no longer relevant. In this case, higher (lower) inflation expectations no longer align with higher (lower) stock prices and higher (lower) economic growth. In this case, a return to macro normality, which prevailed before the 2008 financial crisis, has regained its throne.

My chart relates 5 year inflation expectations and the S&P 500 index.

Dissapearing SP-IE correlation

And my preferred explanation for the absence of correlation since the end of last year is that inflation expectations have converged to the 2% target and will remain there (at least as long as it is believed the Fed will not allow inflation to ‘travel freely’ above it).

In that case, the more recent support for the stock market likely comes from the more ‘durable’ monetary policy commitment embodied in placing thresholds on the permanence of QE3 (not because we´ve returned to “pre-crisis economic normality”).

Search all you like and “thou shall not find”…

…either inflation or who´s responsible for the economy underperforming!

The FT/Alphaville:

Shows a version of this chart.

Blame Game_1

And muses:

Inflation is low and, according to every recent measure, it’s been falling. That’s pretty much all there is to it.

As to the question of how much (or even whether) this disinflationary trend will influence policy, it’s hard to say.

Bernanke suggested in his testimony earlier on Wednesday that he wasn’t so worried about it because inflation expectations have remained stable.

But that´s interesting, in particular because it´s not quite true; in fact over the last couple of months inflation expectations, both the shorter (5 years) and longer (10 years), have been trending down as indicated in the chart below.

Blame Game_2

It´s also interesting because back in 2008, as late as August, the FOMC was very worried about inflation expectations unmooring. The statement from the August 5 meeting reads:

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

Nevertheless, inflation expectations at the time of the August FOMC meeting were down significantly. (Note that 5 year expectation is more sensitive to oil/commodity price fluctuation). The chart illustrates.

Blame Game_3

In August 2008 Bernanke was worried about inflation expectations ‘taking off’, although they were coming down. Now, he´s not worried about inflation getting ‘too low’ because he thinks inflation expectations are stable, although in fact they have come down!

And the blame game goes on unabated:

Federal Reserve Chairman Ben Bernanke thinks Congress is doing quite a lot wrong. He headed to the Hill on Wednesday to present them with an itemized list.

“The expiration of the payroll tax cut, the enactment of tax increases, the effects of the budget caps on discretionary spending, the onset of sequestration, and the declines in defense spending for overseas military operations are expected, collectively, to exert a substantial drag on the economy this year,” he said.

The Federal Reserve can offset some bad economic policy coming out of Congress, but not this much bad economic policy coming out of the Congress. “Monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.”

The result, as Neil Irwin writes, was an unusually blunt testimony from the central bank chief. He basically walked up to Congress and said, “You’re the reason the economy isn’t taking off more.

Blame Game_4


HT AldreyM