The Fed Is Artificially Budging Rates—But Higher Not Lower Does Fiat-Money Central Banking Lead to Deflation?

A Benjamin Cole post

At the always interesting Alt-M website is a post by highly regarded monetary scholar Gerald P. O’Driscoll, pondering if the Fed can raise rates even if it wants to, whether Fed presently is artificially pumping up short-term rates.

O’Driscoll notes that today 20 central banks globally have negative interest rates in place.  Were now an activist Fed to jack-up the Fed funds rate and the interest on excess reserves (IOER) by another 25 basis points, the spread between U.S. rates and global rates would widen even more.

O’Driscoll points out such an action will attract capital to the U.S., thus raising the exchange rate of the U.S. dollar, slowing domestic business activity when the economy barely growing anyway.

Moreover, the Fed appears to be struggling to even keep short-term rates as high as they are. As O’Driscoll notes, in December 2015 the Fed raised interest on excess reserves from 25 to 50 basis points and also posted an offering rate of 25 basis points on reverse repurchase agreements. The Fed’s mysterious reverse-repo program has expanded to $321 billion at recent count, as it tries to sop up enough cash to prevent even lower rates.

But the Fed is battling the tide. O’Driscoll notes interest rates on short-term treasury bills (4 weeks) have recently traded down close to or even below 25 basis points.

Of course, long-term rates are primarily set by market forces, and 10-year Treasuries have been yielding near record-lows, now offering about 1.50% interest.

“There are real questions as to whether further hikes in what are administered (not market) interest rates will move market interest rates as desired. We have no experience on which to base such a forecast,” intones O’Driscoll.

There is much to admire in O’Driscoll’s blogging, but perhaps I quibble with his non-conclusion, which is that, “Fed policymakers are still mostly stuck in closed economy thinking. But, so, too, are most advocates of monetary reform. New thinking is needed all around.”

Well, bring it on, I say. Like what?

The Alt-M Outlook

In the past O’Driscoll has called for free banking, or a gold standard, and noted that modern-day central banks are aligned with nationalist malignancies of financing wars, empire-building, welfare-ism, oppressive state seizure of private assets and inflation.

Maybe all true in the past, but what about inflation since 1982 or so?

In the last 35 years the direction of interest rates and inflation internationally has been down, under globalist central-bank management. Indeed, much of the planet is now in deflation, and the U.S. but one recession away from joining the world. As Milton Friedman noted, you don’t get to chronically low interest rates through chronically easy money. For 30 years we have heard doom from inflation-mongers, and now we have global deflation.

If central banks have an inflationist agenda, they are even more incompetent than we suspect. The admirable Alt-M team still discusses fiat-money central banking as having statist-inflationary agenda. Yet the Alt-M perspective appears out of date, by a few decades.


Maybe free banking or a gold standard will work better than globalist central banking.

But unlike O’Driscoll, I think the problem is globalist fiat-money central bankers are obsessed with inflation and not economic growth. The ECB, for example, appears intent on crushing nations, not promoting statism.

Indeed, for now it would be better if a modern-day Korekiyo Takahashi (Japan’s central banker who ended the Great Depression on the islands) seized the Fed and sent in the helicopters. Darken the skies, and don’t stop until we see robust real growth and inflation north of 4%.

Of course, Market Monetarists contend the practical path forward is central-bank NGDPLT. It may actually happen.

The Alt-M crowd offers plenty of food for thought, but perhaps some updating is needed.

The Fed Is Courting a Lethal Deflationary Recessionary Vortex

A Benjamin Cole post

There is something deeply askew about U.S. Federal Reserve policy statements and policies, and, indeed nearly the entire U.S. economics profession.

For example, a Richard Fisher (former Dallas Fed President and FOMC member), an Alan Meltzer or even a Martin Feldstein can go into sweat-drenched hysterics and predict hyperinflation holocausts, and be consistently wrong for years and years, yet still be VSPs.

But no one predicts lethal (to economic growth) deflationary recessionary vortices. I do. I guess if I am wrong for the next 10 years running—well, then I will still be a VUP (Very Unserious Person).

The Threat Is?

But yet, what is the threat today? Inflation or Prolonged Deflationary Recession?

Has Japan ever escaped its low-growth deflation? Can anyone speak confidently of Europe escaping its deflationary recession?

No recovery lasts forever. At current inflation and interest rates, a recession in the U.S. would surely result in deflation and zero lower bound all over again.

But the Fed has set aside QE, and shows no inclination of lowering interest on excess reserves. To go back to QE or eliminating IOER would mark a humiliating flip-flop on policies—and all the while the naysayers would be screaming, “QE didn’t work. See? We are in a recession again. Only tight money works.”

So the Fed will enter the next recession hamstrung, slow to respond to declining prices and recession (I mean ever slower than usual).


The above scenario perfectly sets up a lethal deflationary recessionary vortex, sucking down equities and property values, eviscerating U.S. savings and balance sheets, scaring off investment in plant and equipment. The Fed will be flat-footed while the economy tanks, and unemployment soars. Federal deficit spending will balloon again, resulting in calls for austerity.

Dudes, it will get ugly.

Instead of welcoming a deflationary recession, the Fed should immediately consider “normalization” of interest rates—on excess reserves, which normally earned no interest.

And if the Fed ever wants real interest rates to be “normalized”, i.e., higher than zero, then it has set help set up sustained and robust economic growth. A central bank cannot “normalize” interest rates through monetary suffocation.

In other words, print more money. Like I always say.

Thinking About Martin Feldstein Again

A Benjamin Cole post

Market Monetarists have already done a superb job explaining why NGDPLT is the best tool for a central bank, especially if measuring real GDP is guesswork—the latter point Martin Feldstein made recently in The Wall Street Journal.

Feldstein’s extraordinarily oblique point was that the CPI or other indexes overstate inflation, something he could not say out loud, so un-PC is such a sentiment. But his conclusion is much more palatable to certain classes, and that is that middle-class America is better off than ever, even if they don’t know it, as wage stagnation is a mirage.

University of Chicago scholar John Cochrane leaped on the Feldstein bandwagon to posit that maybe the CPI overstates inflation by 3%, essentially meaning Fat City for Mr. and Mrs. America. This is a reprise of Bush-era sentiments of economist and right-winger Don Boudreaux of George Mason University.

Is The Fed Suffocating The Economy?

That Cochrane likes the Fed now is not much of a surprise; he has argued that deflation is the economic cure-all, notwithstanding the 20-year long debacle with falling prices that is Japan.

Cochrane says that Feldstein’s premise today means in the United States “we really have 0% nominal interest rates, 1.5% deflation rather than 1.5% inflation; +1.5% real rates rather than -1.5% real rates. That is about the ideal monetary policy.”

Cochrane then exults, “We live the (Milton) Friedman optimal quantity of money.”

But others may wish to ponder if the Fed, by accomplishing less than 2.0% inflation as measured on the PCE, is actually obtaining minor deflation, and thus Japan-like results.

As widely noted, economic growth in the United States since the Fed ostensibly set its 2% PCE IT (which many suspect works out to 1.5% in practice) has been…well, Japan-like.

In 2015, the first half GDP may exhibit some real economic growth, but may not with any bad luck. Industrial production has been falling through most of the year. And the previous seven years have been anemic. If this is the Friedman optimum….*


If after seven years in the United States, and 20 years in Japan, the Friedman optimum does not work in real life, then we can dispense with deflation as reasonable monetary goal. It just does not work in the here and now.

On the contrary, I wonder how long the United States could be in boom times before we saw old-fashioned demand-pull inflation. The 1990s was pretty boomy, and inflation remained moderate. Maybe there is another lesson there, too.

As I always say, the Fed should print more money.


*Friedman may have opined about a theoretical optimum. But in practice he advised Japan to pursue QE hard and heavy, and three times criticized the Fed for being too tight; in the Great Depression; in 1957; and in 1992. Did Friedman ever advocate a real-world policy of deflation?

The Right-Wing Should Be Sweat-Drenched Hysterics—About Deflation! “Soak The Rich, Who Cares?” Will Be New Global Anthem

A Benjamin Cole post

Okay, this will take some explaining, but deflation is a tax-dagger pointed right at the purses of the wealthy in developed nations.

It goes like this: In high-tax developed economies (i.e., the West and Japan), deflation results in explosions in cash in circulation. Evidently, people and businesses start to save in the form of cash, and then start doing transactions in cash to avoid the tax-man. Dealing in cash becomes socially acceptable.

The problem is people and businesses in the underground economy do not care about taxes. The state needs more money for welfare and warfare? Fine, let ‘em raise taxes!

And who pays income taxes? Who will be left operating legitimate aboveground businesses?

Cash Is King

We see now in the United States more than $4,200 in circulation per resident, and perhaps double that in Japan, the latter long in the throes of deflation, and where many businesses do not “take plastic.” In Europe, euros in circulation have exploded by 66% to €3,600 per resident since 2008 and deflation, despite a stagnant economy and population.

Academic economists have ignored the cash economy—one that cannot be measured, and which only indirectly contributes to official data. The official data is increasingly inaccurate, one might add.

Academics are left with the dubious stance that U.S. cash is offshore and in suitcases doing drug deals. Because they saw that in the movies?

And what explains the explosions of euros and yen in circulation?

The Upshot

So, we in the West we are heading towards deflationary bifurcated economies, one half aboveground, regulated, expensive and taxed, and one half untaxed, unregulated and less expensive.

Oh, guess which is the growing part of such economies?

Of course, disrespect for the law and state can be contagious; see Prohibition in the United States. Once cheating on taxes becomes a virtue…well, see Greece.

Maybe it is better to live with prosperity, an above ground economy and 3% inflation or so.


At ZLB-Deflation, High-Tax Economies Go To Cash. Well, Duh. The Banana States of America? Or Japanification?

A Benjamin Cole post

It makes perfect economic theoretical sense: If businesses and consumers face high taxes, but operate in deflationary environments, they will migrate to off-the-books cash savings and transactions.

And what do we see in Japan, Europe and the United States?

Explosions in cash in circulation in deflationary environments—and not a topic of polite conversation in economist circles.

Paper Money Everywhere  

In the United States, there is now more than $4,200 in circulation for every resident. In Japan perhaps $8,000 in dollar equivalents (depending on exchange rates) and in Europe about €3600, that figure up a thumping 66% since 2008 (more on that later).

When did Japanese cash in circulation start to boom?

“As a proportion of nominal GDP, (Japanese cash) banknotes in circulation held mostly steady just below 10% until the mid-1990s, according to the Bank for International Settlements. It then rose to 19% by the end of 2012, more than twice the level of any other developed economy,” reports The Wall Street Journal.

And what was happening in Japan in those years? As every reader of this blog knows, deflation started in 1992 in Japan, a modern, high-tax nation. The WSJ also reports that many small business in Japan will not “take plastic.”

Now that deflation is king in Europe, so is cash, with euros in circulation up two-thirds since 2008, despite a stagnant population and economy. Notes the ECB, “Interestingly, the additional (Euros) banknotes that came into circulation since 2008 have not yet been returned to the national central banks of the euro area. This indicates that people both inside and outside the area are keeping hold of them.”

Duh. Levy heavy taxes, go to deflation, and people and business migrate to cash.

Upshot: Deflation And Commercial Anarchy?

In the longer run, the exploding cash in circulation suggests a deflationary modern economy will bifurcate into a taxed, expensive and possibly stagnant aboveground economy and cheaper, growing grey markets.

In the United States, the robust growth of Craigslist and eBay and other online transaction websites indicate a growing and healthy web-enabled grey market. (Anecdote time: I worked in small manufacturing in Los Angeles for twenty years. Cash is king, dudes. Get over it).

This reality of cash strongly implies that a benign deflationary economy, as posited by University of Chicago scholar John Cochrane and others, is impossible in Western nations, or would require draconian tax enforcement, or cashless economies that make fictional Orwellian societies look like pansy-states.

Indeed, as more people and businesses become comfortable with saving in the form of cash and dodging taxes, they will also become more comfortable with transactions in cash. The aboveground will have to be taxed even more heavily to compensate for lost tax revenues, a banana-state problem. And where does that lead?

I do not share the ability for apocalyptic visions that so enrapture the gold nuts and anti-inflation hysterics. Then I could say I see catastrophic consequences ahead, even anarchy, in the deflationary state.

But it seems clear that with chronic deflation will come a permanently growing and untaxed underground cash economy, now already estimated at some 20% of GDP. A tipping point may be reached, when the aboveground economy moves into permanent recession, thanks to cheaper cash competition. Did I mention Japan?

And for theoretical economists will then come the “real crisis”: Your economic models and postulations will rest upon reported figures of increasingly dubious veracity.

Why doesn´t Martin Feldstein take a hike?

MF is back at his favorite subject: US inflation:

The Federal Reserve now faces the tough task of unwinding the easy-money policy that has helped bring about the current solid economic upturn. But its projected path for increasing the short-term federal-funds rate over the next few years is dangerously slow. Most members of the Federal Open Market Committee want the real interest rate to be negative at the end of 2015 and approximately zero at the end of 2016. Only in 2017 would the real fed-funds rate even exceed 1%.

Overall unemployment now is 5.5%. This has historically been regarded as about the lowest rate that can be sustained without starting an inflation spiral. The Fed is nevertheless projecting that its policies will cause unemployment to decline to 5% by the end of 2015 and even lower in the next two years. Historical experience suggests that means inflation would eventually increase year after year.

And on he goes, wrong on all counts!

But his views have become a stale joke. Six years ago [April 09], for example, he saw “inflation looming”:

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again [what certainty]. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

However, we know commodity and oil prices have fallen again – headline inflation is again courting negative rates while core prices are now up only 1.4% –  and the (inflation) outlook is anything but ominous! That´s not just hindsight. MF had (and has) only a few inflation-nutters of this caliber riding along.

China Has A Better Central Bank Than The United States Sino-Superpower To Surpass States Sooner?

A Benjamin Cole post

It is one of the oddities of our time that Communist China has a central bank that is more growth-oriented than that of the bastion of free enterprise, the United States.

The Federal Reserve’s FOMC should pack their bags and fly to Beijing to see what real central banker looks like, that being Zhou Xiaochuan, top man at the People’s Bank of China (PBoC).

Zhou, 67, just issued a warning “about signs of deflation and said he was closely watching slowing of global economic growth and declines in commodity prices, while speaking at forum on the island of Hainan.”

BTW, we Market Monetarists often beat up on media-folk for their inept reporting. But I agree with this bit of in-story editorializing from Reuters, “Beijing is determined to keep the Chinese economy…from taking the same path of recession and deflation that has blighted its neighbor Japan for the past 20 years.” Maybe even wire-reporters are better central bankers than the present FOMC.)

The Stats: China vs. U.S.A.

Now consider this: inflation in China is not much different from that of the United States, coming at 1.4% in February. The U.S CPI for last 12 months is 0.0%, but to bend over backwards to be fair, it is 1.7% core.

China’s GDP is growing by about 7%, and the U.S posted 2.2% in Q4 2014, and may be slowing.

So which central bank (if either) should be thinking about stimulus and fighting deflation? Is something backwards?

The PBoC vs. The Fed

But it is the PBoC that has cut interest rates twice recently, and lowered bank reserve requirements, while the Fed endlessly pines for the day it can raise rates, and rhapsodizes euphoric at suggestions it sell off its balance sheet.

The PBoC sees inflation under 2% and moves to stimulus. The Fed sees inflation under 2% and moves to..,tighten?

The Upshot

Economists, at least of certain stripes, love to blame structural impediments for slow growth in Western democracies, and in the United States. But that does not explain the 20% real growth of U.S GDP from 1976 to 1979, when the U.S. had an expansionist central bank.

And are we to believe that centrally planned, hopelessly corrupt, state-controlled communist China does not have structural impediments? How does China grow at 7% annually?

It is unknown if China can prosper in years ahead. Due to barbaric government civil-rights policies and communist party control of everything, the rich and smart want to leave China. That is a very serious structural impediment.

But I suspect the United States cannot prosper with ongoing Federal Reserve policies. The States are headed down the Japan road. The blighted one.

The future belongs to China? Maybe. If so, the central banks played lead roles in the tale of two nations.