Tuesday, August 10, 2010

Feds yell "bomb" inside a crowded savings account...

Lets use an analogy: since the US Federal Reserve is the policeman for our monetary system, we will compare their actions to policing a theater. Their stated goal is to maintain stability (prices), while maximizing the number of people watching movies in the theater (full employment). Under normal circumstances, movie patrons are courteous, polite, and anxious to get inside and watch high-quality theater fare (i.e-such as "Black Dynamite").

But what happens when there is a slowdown and cinematic-poo like "Macgruber" is showing on the main screen?

People may still show up at the theater on Friday night wanting to see a movie, but would be unwilling to sit down and suffer the 90 minutes of pain called "Macgruber the Movie". While patrons may choose to wait quietly in the lobby for a better movie to start up, this is not politically or economically viable for our "theater police". The regulatory mandate is to maximize employment (people watching the movie, regardless of what is showing). As such, watching and waiting for a better movie or story to come along is not acceptable.

So, our "theater police" (Federal Reserve) spring into action... first they cut the price of movie tickets by half (lower interest rates). But what if people still choose not want to watch the current "movie" (i.e- spend money, shop, buy houses, consume)?

Well, what if the theater police used their power to scare patrons, with the following threat: "Go inside and watch the current movie, or we will make sure you can never see a movie again!".
If the threat is perceived as real, many patrons would reluctantly go watch the film, no matter how bad. Does the outcome justify the means? Are such strong-arm tactics appropriate for regulators/authority to use? Does shattering any sense of stability to to achieve full employment make any sense at all?

This is at the crux of recent economic silliness (some would mischaracterize it as "debate"). Most recently, one of the Federal Reserve Board governors (James Bullard, St Louis) noted that the massive and unprecedented expansion of US money supply (trillions, with a T) has not caused economic activity to increase significantly. Bullard goes onto suggest that an appropriate course of action would be for the Federal Reserve to scare the populace by printing even more money (under the term "quantatitive easing"). Bullard's logic is that causing individuals to panic-spend their life savings (because they are scared of their government debasing the currency) is preferential to slow economic growth.

Going back to our theater analogy, we now have someone in authority suggesting that it would be appropriate to yell "Bomb" in the lobby of a crowded theater, under the auspices that it might make some people run further into the theater (perhaps accidentally into where the movie is being shown). The problem is that some people will run out of the theater altogether and never come back (avoid US$ currency exposure), while the individuals inside the theater will be panic-stricken about when the bomb is set to go off. The inadvertent horror of watching MacGruber the Movie will become the least of their worries!. Alas, that leaves us with a careless regulator that has witnessed the carnage and tries to undo the damage by saying, "Just kidding, I was not going to blow the place up".

Such thinking is not bourne of responsible, intellectual leadership. No, not even for the purpose of "evoking a debate". If you yell bomb on an airplane, you are arrested. End of story. If our Federal Reserve Governors yell "bomb" with respect to the savings of the average American, do they expect it to generate productive, long-term investment?

Lest you think the dissertation above is hypothetical, I have attached a link to an utterly embarrassing research paper posted by an irresponsible member of the Fed Board of Governors, James Bullard.


PS- Why do central bank decisions matter?

Your savings(if denominated in US$) are directly managed by our US central bankers at the Federal Reserve. Although hypothetically controlled by our Treasury Department, the Fed which actually controls the amount of currency in circulation. For example, while it may have taken you twenty or thirty years to accrue a fixed-income pension, a small social-security-stipend, and perhaps a modest sum in your bank account..... our central bankers can conjure up a similar sum within a millisecond.

In truth, our central bankers can conjure up many multiples of our country's net worth within a few milliseconds, thanks to the wonders of computers and electronics (no more waiting for an outdated printing press to crank out all those bills by hand!).

So why does this matter? Well, your "savings" only have value to the extent that a purveyor of physical goods/services(i.e- grocery store, Best Buy, etc.) has demand for your currency. If our central bank doubles the supply of currency in circulation overnight, the value of your currency is debased (cut in half). It may take awhile for most people to recognize this. If you are earning minimum-wage working at a bowling alley, you will continue to earn your minimum wage....but that person has taken a significant pay-cut relative to his real cost of living. Unless the minimum wage worker has significant real-estate holdings or hard-assets (i.e- gold) lying around, such currency manipulation harms his interests. It harms the citizenry as a whole.

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