#BTColumn – The wrong targets (The pandemic, Putin and Petroleum)

“How easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes.” – Fiat Money Inflation in France

This writer might be the world’s biggest fool, but don’t let the powers that be (especially monetary) take you for one. Working folk of small fortune do well to remember that we are still in the throes of the greatest failed monetary policy experiment in human history. The continuing fallout from (and enabler of) this failed experiment is grounded, not in greed (or grenades), but a governance gap.

Henry Thornton’s warnings in Parliament and the press on the controversy of currency, are equally true of our monetary mess as it was in his day, “the increase of industry will by no means keep pace with the augmentation of paper.” Nobody, certainly not “greedy” capitalists, can out-gouge governments addicted to artificially low interest rates using central banks to monetize debt.

The details need not detain us. For now it is sufficient to say that inflation is a non-legislated tax (especially) when the government is the first recipient of the new money supply (in exchange for treasury bonds). By the time the last recipient receives the now not so new money, their purchasing power has diminished considerably.

Nassim Taleb made the point that “learning from history does not come naturally to us humans, a fact that is so visible in the endless repetitions of identically configured booms and busts in modern markets.” There is a more vicious side to oft repeated truism that those who don’t know history are doomed to repeat it.

We are also in danger from people who know the past too well. Taleb writes, “those who are very good at predicting the past will think of themselves as good at predicting the future, and feel confident about their ability to do so.” Historical mistakes can be embedded in the present not only through ignorance of the past but predictors of it.

Fast forward to the present. The Bank of Jamaica (BOJ) announced its fourth and most “dramatic adjustment” with interest rates now at 4 percent, the highest since June 2017. Since the Keynesian revolution and the emphasis on price stability, monetary authorities focus on inflation targeting, defining price stability at around 2 percent inflation.

After concerns were raised about possible bad debt and business closures as a result of the most recent hike, the BOJ issued an assurance that the financial system was adequately capitalized to deal with any shocks from these hikes. One commenter had a chuckle about inflation targeting, a ship that has long sailed (along with important lessons from 2008).

The BOJ is also refreshing its bank notes and launching a new $2,000 note this year to coincide with the country’s 60th independence anniversary celebrations. One commenter reasoned that they would rather have more value added to the existing notes (wouldn’t we all). The inflation targeting ship has not only long sailed, it has left consumers completely out to sea.

It is significant that the 2008 crisis happened without any red flags in the traditional targets/indicators like high inflation or unemployment. One of the better papers I’ve come across on the previous crisis will be a prerequisite for understanding the next. It was penned by Scott Sumner who touched on the highly flawed nature of consumer price indices while making the case for nominal GDP targeting. His honesty about the myths in macroeconomics was refreshing.

But first we need to (re)visit Allan Meltzer’s magisterial history of the Federal Reserve, specifically a section in Volume 1 that deals with the period 1923–1929. Meltzer’s observation that many of the principals during this period were “weak men with little knowledge of central banking and not much interest in developing their knowledge”, should not deter us.

Aldoph C. Miller, one of the original Governors, thought the price index was the wrong target for precisely the reason we are seeing now: “To the extent that the Federal Reserve System can do something useful and constructive …, it has got to have a far more competent guide than the price index offers. […] you cannot wait until inflationary developments register themselves in the price index.” (Ship done sail, long before Putin and petrol.)

Imagine two archers practising in an open field. One is consistently hitting the bullseye or thereabouts while the other is missing the target completely. If both archers are aiming at the right target we could conclude that, on this particular day, one archer is better than the other. But there is another possibility.

Perhaps both are failures aiming at the wrong target. Hitting the bullseye (or thereabouts) of the wrong target is infinitely worse than missing the wrong target completely. The latter might be cause for pause; we might even walk up to the target and inspect it. The former lulls us into a false sense of security that all is well, when it isn’t. This is exactly what happened prior to 2008.

Federal Reserve policy was influenced by a political “solution” to make housing more affordable. It is a tragic irony that several people lost their homes because of a political “solution” to make housing more affordable. Newly created money was directed to a good whose price is not included in the consumer price index (CPI), which includes the cost of living in a house not buying one.

A good economy will exhibit good indicators, but good indicators are not necessarily indicative of a good economy. Absence of evidence (of harm) is not evidence of absence (of harm). The housing component, which makes up about 40 percent of core CPI, was increasing during the greatest housing collapse in American history. Read that again. Now frame this: Always trust your reality over the models of your monetary authority.

Boom-bust cycles are inevitable not because we are ignorant of the past but because predictors of the past know it too well (with “increased statistical confidence” and all that jazz). As the plot thickens in the Monetary Matrix, the Politburo will continue to blame Greed Inc. and monetary masters will ramp up the rhetoric about “fighting inflation”.

In Monetary Equilibrium and Nominal Income Targeting, Nicolás Cachanosky notes that “it should be patent now that price level stability is not a synonym of monetary stability.” Contrary to the predominant view that an efficient monetary policy should aim at consumer price level stability, Cachanosky makes a good case for why monetary masters (now turned central planners) should aim elsewhere.

The pandemic, Putin, and petroleum are unfortunate accelerants of the fallout from the aforementioned failed experiment. Keep yourself from idols (1 John 5:21).

Adrian Sobers is a prolific letter writer and commentator on matters of social interest.