Tuesday, January 29, 2008

Learning to Be A Central Banker in 10 Easy Steps

Start with one policy - for example - interest rates. Place the policy ball in your right hand and begin by lowering rates. which causes the ball be tossed-up into the air, in an arc, and land in your left hand. Note how, when the policy ball is in your left hand and you raise rates, the ball returns in an arc to your right hand. Repeat several times to get the feel. (Note this doesn't work if you are left-handed)

Now with he first policy ball in your left hand, take a second policy ball in your right hand, say the value of the US dollar. Notice how when you lower interest rates while the PBoC, and other official buyers in BRICs and GCC countries buy Long Bonds, the 2nd policy ball, the Dollar, feels heavy as if it wants to fall to the ground. Exerting appropriate pressure, you must force it up to arc, after which it should fall back down landing in the left hand.

Now with interest rates in your left hand, and the FX value of the dollar in your right hand, try to toss the rates lower, and as they arc downwards, you will need to jettison the dollar. Be certain to avoid the common mistake of throwing up rates too high if the dollar is NOT falling.

After letting the dollar fall for a while (note the nice concave arcing pattern in the picture), you will need to catch it with your right hand firmly by attempting to pay some lip-service to a strong-dollar policy. This permits the official entities who are at once your friends and your enemies, to get off the hook by buying dollars under the premise that you do care about its value.

Warning: Under no circumstance should you allow the policy balls to collide by lowering rates AND letting the dollar fall. Or else you might ultimately have to raise rates, making the introduction of the 3rd policy ball very difficult.

Get the hang of things by practicing tossing the two balls, raising and lowering interest rates as required, and jawboning (and where necessary) letting the dollar fall to floor. See if you do this while reciting Humphrey-Hawkins-like testimony, and answering your wife's questions.

Now quickly, you will find a third ball in your hand whether your ready for it or not, for as rates have been raised to pay lip service to inflation and the falling dollar, the third ball, economic growth, needs to be tossed into the air. Be careful NOT to make the common mistake of walking in circles while juggling the balls.

Irrespective of how high you toss it, will begin arcing lower as the economy begins to falter. Just before you catch the falling economy with your left hand, you will have thrown the rates ball back your right, while the dollar accelerates its decline towards your left, such that you can start all over again. It is essential to avoid changing the policies in a staggered rhythm.

As the economy climbs back on its arc to your right, you will be catching interest interest rates with your left, having sent the dollar on a stronger trajectory with your right, before repeating the exercise. Be sure not to launch the interest rate ball too high or too far in front of you.

Congress at this point will be demanding that you pay the most attention to the economy ball, so you must learn to turn your back (on them), and see if you can juggle behind your back as in the diagram (right).

CONGRATULATIONS! You are now ready to set monetary policy for the largest economy in the world!!

NEXT WEEK: In your next lesson we'll introduce balls 4 and 5 in the form of a sub-prime crisis, and banking system solvency issues, just for fun!


Mencius Moldbug said...


I do believe that after 175 years, you've rediscovered the ol' currency juggle.

The Messrs. Attwood certainly have much o'erpowered Mr. Mill in evangelizing their great message of hope and possibility. Perhaps that's because people would rather hear positive, encouraging ideas than carping, negative pessimism, like yours and Mr. Mill's. Hm.

"Cassandra" said...

I am always amazed by the lingering of such obscurity in your head, and your ability to reel them in when desired. Though all my drivel is laughably undeserving to share the same page as Mr Mill's, we do apparently share one thing: an appreciation of the southern Rhone, a place where curmuddgeons and cranks alike can find a natural beauty and quality of life to soften our "carping, negative pessimism"....

Anonymous said...

So Cassandra where is the next bubble going to be in your opinion? With Benny and the bubble blowers coming to the party with a full crack pipe and the unintended consciences that have always followed these types of event there is going to be one somewhere. No?

"Cassandra" said...

A rip-roaring recession could drive a bubble in "safety" and investment conservatism?!?!

But its not a deterministic outcome over the medium term that some bubbble must inflate from easy money and negative real rates. We could just see inflationary recession - driven mostly by the commodities that by all accounts of supply and demand should be roaring ahead and become more dear in a world with greater dispersion in purchasing power that consequentially is driving demand basic goods and investment - investment that's mostly saturated in the developed world. Real house prices - with only mild falls of 5% yr with 6 to 8% inflation would quickly see mean levels of affordability once again, and the problem would be spo-to-speak "solved". Of course the burden would have been stealthily shifted to savers, with the biggest losers being (1) the very accumulators of US debt that enabled it in the first place, and (2) Us-the-people , through the large losses in our own pension funds, and the pension funds that we've underwritten via state obligations, since we'd actuarially be rather in a fundding pickle were we en masse to ratchet-up inflation forecasts to near double-digits. In the big picture, the anomaly has been that the bond-market - the inflationary canary-in-the-coalmine - has been neutered, partly by foreign official intervenntion, and partly because of the authorities permissiveness of and tolerance of the shadow-banking system which in a nutshell creates the leverage to the fill the arbitrage opportunity even where the risk of such opporuntity is not commensurate with the reward, unless you are an agent with a very short time-horizon.

"Cassandra" said...

in the last sentence I meant of course where the "reward is not commmensurate with the risk",

Mencius Moldbug said...

Where is the next bubble? Where is the safe haven? And who is the new canary? Ockham suggests that all these questions may have one answer. It doesn't sing or eat birdseed. But it's still yellow...

The problem with a precious-metals "bubble" is that PM prices (or at least gold prices - though the platinum situation is interesting; if I had money in London I might throw a little at PHPT; things in SA are not about to get better) are already in a bubble. And have been for about the last 5000 years. They certainly cannot be explained in terms of any direct uses of these substances.

A housing bubble or a stock market bubble is constrained by the fact that above a certain price level an arbitrary and absurd supply of houses, or factories, or whatever, will enter the market and pop the bubble. The prices of these assets cannot be sustained above the cost of producing them from goods that are effectively inexhaustible. (The land aspect of real estate protects bubbles to some extent, but only in some places - the real poppage in my parts is not in SF, but Sacramento, Livermore, etc.)

PMs are different. Deposits are limited. They can be simply capitalized as the price rises. New veins will not magically appear.

Do I think we will see gold at $10K/oz? I have no friggin' idea. But one thing I am sure of is that gold can sustain a price of $10K/oz, or even $100K/oz. Production would certainly rise, but not perhaps as much as you think. These eco-people are pesky.

At least, gold at $100K/oz is economically stable. That doesn't mean it's politically stable.

CBers have been trying to raise the price of their product relative to gold for the last 300 years. In Bagehot's time it used to be said that 10% rates would draw gold out of the ground. In 1929-33 this was tried and it didn't work. The monetary system had been too badly abused. Too much paper.

In 1980 it was tried again and it did work. Although the rate was not 10, but more like 20. Sadly, the opportunity that Volckerism created was not used to stabilize the financial system and return permanently to some kind of sound money. It was used to embark on a quarter-century banquet of speculative excess and glorious irresponsibility.

The waiter has just showed up with the bill. The "canary" is speaking up. Birdseed will not satisfy him.

Anonymous said...

The next bubble will definitely be in brains. They're in a finite and even decreasing supply. IMHO.

tooearly said...

Mencius: as fine a comment as i have ever read...
Cassandra: what a jolly post that was...makes me want to learn to juggle

Anonymous said...

Thanks Cassandra, I loaded up on gold \ silver in 02, sold my home in 05 which was paid for, bought a farm which I paid cash for and have no debt. Not all Americans are stupid just most of them especially the younger ones. The only thing that troubles me about the inflation forecast is with all the home and equity wealth being vaporised, tighter lending standards, and unworthy borrowers it seems like that would be deflationary to me. The one question I keep asking is when will forgein investors be fed up and stop buying US bonds and funding this insanity.

Anonymous said...

Regarding your (and moldbug's) shared appreciation for the southern Rhone, please find the following quote from Peter Mayle's, 1991 "A year in Provence".
"The beauties of nature were loudly praised every evening on the ramparts of Menerbes, and I particularly liked the comments of an elderly English couple as they stood looking out over the valley.
"What a marvelous sunset" she said.
"Yes" replied her husband. "Most impressive for such a small vilage"

Anonymous said...

Please forgive in advance a second consecutive post. With regard to that yellow substance which is not birdseed, let me suggest an alternative:cake.
Yellowcake, that is, or as it is also known Uranium oxide. It is not widely dispersed, (Canada USSR, Kazakhstan, western USA) and has many nice things to recomend it. One is that nuclear plants have been living for years off de-comissioned nuclear weaponry. This phase is over. New Supply is TIGHTLY controlled (Areva, Cameco) dominate western world supply.
China plans to build 30 new plants over the next 20 years. India will also build new plants, though they may use a unique Thorium based technology.
When you have a pig and the price of feed quadruples, you kill the pig. When you have a 3
billion dollar race horse and the price of feed quadruples, you keep feeding it. Nuclear power plants, once built, are instances of the latter.

"Cassandra" said...

Woland - the joke around Menerbes was that after he wrote the book and brought all the prats of the world to a once unspoiled part of the world and turned it into a weird stylized wunder-Disney for wealthy 50++, raising the price of everyone's coffee and wine x2, tourists would ask if this is where Peter Mayle wrote about, and the People would answer effusively yes, and he only lives around the corner, here's the address, please go see him, he so adores visitors popping round....

Mr Mayle apparently shuttered his emblematic (though lovely) mas abutting the petit Luberon, and moved to .... yes .... Lon Gisland for some peace and quiet.

Anonymous said...

Quite right. I simply loved, and still love, the line: "Remarkable for such a small village". It was my
ONLY point in posting the comment. Just trying to keep up the cheer level.

"Cassandra" said...

Thanks 'tis appreciated.

Yes, like many ostensibly good people, the kind that would be entertaining dinner party guests, Peter Mayle's sensibilities and aesthetics are good. But then something [natural?!?] sets in, and he wonders how can I profit from it, in the process, immediately spoiling "it", "its" authenticity, and making a caricature of what was once tradition. Maybe as humans we subconciously need validation. Perhaps it is merely ignorance and an inability to project consequences foward.

The difference now, between the "the Golden triangle" - looking more and more over-stylized with fewer and fewer locals - vs. what exists nary 40km away, is like the difference between spic-n'-span freshly painted white-house-black-shuttered colonial with painted picket fence in southern Vermont, and the near-hillbilly existence of NewHampshirers (the only state to abolish MLK holiday) to the east and upstate NY to the west, where every car Ma' & Pa' every owned is up on block sans tires in the front yard, adn various old washing machines & tumble dryers sit rusting adjcently.

Anonymous said...

i was going to link to the San Fran Fed's infectious game of playing Fed chairman, but apparently it's been taken down for "updating". Hmmmm.