“But to in­fer that an im­me­di­ate start to fur­ther hikes is a no-brainer is lu­di­crous. In fact, there is still a world­wide down­ward draft on in­ter­est rates , with the ECB and the Bank of Ja­pan still very much in eas­ing mode”

Financial Mirror (Cyprus) - - FRONT PAGE -

In his re­cent de­bate with his op­po­nent Hil­lary Clin­ton, Repub­li­can pres­i­den­tial can­di­date Donald Trump pressed his claim that US Fed­eral Re­serve Chair Janet Yellen is po­lit­i­cally mo­ti­vated. The Fed, Trump claims, is ap­ply­ing over­doses of mon­e­tary stim­u­lus to hyp­no­tise vot­ers into be­liev­ing that eco­nomic re­cov­ery is un­der­way.

It’s not a com­pletely crazy idea, but I just don’t see it. If Yellen is so de­ter­mined to keep in­ter­est rates in a deep freeze, why has she been try­ing in re­cent months to talk up longert­erm rates by in­sist­ing that the Fed is likely to hike rates faster than the mar­ket cur­rently be­lieves?

Cen­tral bankers have of course been known to help in­cum­bents be­fore elec­tions, by al­low­ing in­fla­tion to drift up and keep em­ploy­ment boom­ing. Dur­ing US Pres­i­dent Richard Nixon’s 1972 re-elec­tion cam­paign, he sternly lec­tured Fed chair Arthur Burns on the need for pump­prim­ing the econ­omy to help him de­feat his Demo­cratic challenger, Ge­orge McGovern. Nixon won re­sound­ingly, but Burns’ poli­cies helped set off the world­wide in­fla­tion of the 1970s and brought for­ward the breakup of the post-war sys­tem of fixed ex­change rates. The long-term ef­fects were cat­a­strophic.

Will Yellen launch a re­run of the bad old 1970s, when US in­fla­tion hit dou­ble dig­its? I doubt it. Al­though it is not hard to imag­ine that Yellen pri­vately holds Trump in the same low re­gard he holds her, most ob­servers see no signs that in­fla­tion is just around the cor­ner.

True, some peo­ple still in­sist that if the Fed doesn’t ur­gently raise in­ter­est rates and rein in the money sup­ply, the US econ­omy will go the way of Zim­babwe (where in­fla­tion far ex­ceeded 25,000% in late 2008). But the ar­gu­ment that Fed balance-sheet ex­pan­sion will trans­late into high in­fla­tion has been colos­sally wrong for the past six years.

In­fla­tion in the US has been con­sis­tently be­low tar­get and, even to­day, bond yields re­flect deep skep­ti­cism about whether the Fed has the will or the ca­pac­ity to sus­tain price growth at the of­fi­cial 2% tar­get on a con­sis­tent ba­sis.

In­deed, those cen­tral banks that have tried rais­ing in­ter­est rates pre­ma­turely, in­clud­ing the Euro­pean Cen­tral Bank and the Swedish Na­tional Bank, have been forced to re­verse course, and the Fed wants to avoid that fate. The US econ­omy is per­form­ing far bet­ter these days, and the mo­ment for rais­ing rates fur­ther is likely near.

But to in­fer that an im­me­di­ate start to fur­ther hikes is a no-brainer is lu­di­crous. In fact, there is still a world­wide down­ward draft on in­ter­est rates, with the ECB and the Bank of Ja­pan still very much in eas­ing mode, as are many smaller cen­tral banks. The Fed is al­ready al­low­ing some tight­en­ing sim­ply by not play­ing along, and let­ting the US dol­lar ap­pre­ci­ate.

To be fair, cen­tral banks are not im­mune to ma­nip­u­la­tion, and fight­ing off po­lit­i­cal pres­sures is an end­less bat­tle. Dur­ing the fi­nan­cial cri­sis, the mon­e­tary au­thor­i­ties were called on to as­sume tem­po­rary emer­gency pow­ers, in­clud­ing mas­sive pur­chases of govern­ment and pri­vate-sec­tor bonds. For most, in­clud­ing the Fed, there is still no clean exit in sight, and this has made the prob­lem of po­lit­i­cal in­su­la­tion more dif­fi­cult, with or with­out an elec­tion.

Some be­lieve the only sal­va­tion is a re­turn to the gold stan­dard era of the late 1800s, when gov­ern­ments fixed the price of their cur­rency in gold, leav­ing lit­tle scope for po­lit­i­cal in­ter­fer­ence. Un­for­tu­nately, gold bugs seem sur­pris­ingly – or per­haps will­fully – ig­no­rant of the chronic fi­nan­cial crises and deep re­ces­sions of that era. Ul­ti­mately, the gold stan­dard col­lapsed, af­ter gov­ern­ments were forced to aban­don it dur­ing World War I and there­after were never able fully to reestab­lish pub­lic trust.

More for­ward-look­ing thinkers point to pri­vate cryp­tocur­ren­cies like Bit­coin as the fu­ture of money, ar­gu­ing that they take pol­i­tics out of the equa­tion en­tirely. But this, too, is very naive. Gov­ern­ments al­ready can block cryp­tocur­ren­cies from cir­cu­lat­ing in the le­gal econ­omy by re­strict­ing bank ac­cess, im­pos­ing tax laws, and by also im­ped­ing re­tail stores’ abil­ity to ac­cept it. (And, as I ex­plain in my new book The Curse of Cash, Bit­coin can hardly be con­sid­ered a long-term sub­sti­tute for large-de­nom­i­na­tion bills.)

Yes, blockchain tech­nol­ogy is very ex­cit­ing and will likely have many ap­pli­ca­tions in bank­ing, fi­nance, and across the econ­omy.

But it is no guar­an­tee against po­lit­i­cal in­flu­ence on in­fla­tion. In the long his­tory of cur­rency, from coinage to the ad­vent of pa­per money, the pri­vate sec­tor may in­no­vate, but ul­ti­mately the pub­lic sec­tor ap­pro­pri­ates. At the end of the day, the govern­ment will al­ways be able to con­trol the rules.

Iron­i­cally, the best way to in­su­late cen­tral banks from po­lit­i­cal pres­sure would be to ex­pand their toolkit to al­low for ef­fec­tive neg­a­tive-in­ter­est-rate pol­icy, though this will take time (as I also dis­cuss in my book). In the mean­time, the Fed and other cen­tral banks will have to keep walk­ing a tightrope that leaves them es­pe­cially vul­ner­a­ble to out­side pres­sure. For­tu­nately, the Fed has a chair right now who is able and will­ing to stand up to it.

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