Lesson 15 Money and Monetary Policy

Janet Yellen is the head of the Fed. She and her colleagues at the Fed determine the nation’s money supply. Much has been said about her management of money and lately she is being labelled a lackey of the President and Mrs. Clinton. I doubt she is lackey but I would say that she is guilty of drinking the same Kool-Aid as her liberal progressive buddies in government.

We grew up with Kool-Aid and I don’t mean to disparage that lovely and colorful drink with enough sugar in it to start a diabetic colony.  What I mean is that Yellen, Obama, Clinton and many others share a similar philosophy in general and in particular with respect to the magical qualities of money.

And that’s what makes this post today so much fun. Money itself is about as exciting as your Uncle Ed who rocks himself to sleep at 1 pm in the living room while you watch his cigar ash fall on his partly open bathrobe. Money is paper. Or money is electronic entries that get transferred from one account to another. 

This is not exciting stuff. You buy something – whip out a bill or a debit card – and the deed is done. Nothing to write home about there. It’s like your best friend Peter. You wear plaids and so does he. You wear stripes and so does he.

Although money itself lacks any real excitement, governments can turn it into Charlie Sheen on crack. There was a day when the world did not have money. We called that barter. A farmer would trade three carriage loads of corn for two dresses. That worked okay but corn farmers could not always find dressmakers and so pretty soon money evolved. If everyone carried money it made transactions much simpler.

Money went through a number of stages. Money needed to be around. At first it was commodities – stuff that most people already had and knew the value of – like corn or wheat. Then they were replaced by commodities that seemed to be more durable and held value better – like silver and gold. Silver and gold are pretty but those commodities are heavy or bulky and not easy to safeguard or carry to Sam’s Club. The next stage created paper money  wherein the paper money had to be backed by gold. Paper was essentially valueless but it represented an amount of gold.

Are you history-lovers still awake? Finally came the stage where money could be pulled out of a hat. Not really a hat but essentially the same thing. Central banks create money at will. They need nothing but a magic wand and an Internet connection. Money is “backed” by faith that the central bank will always create the right amount. Not too much and not too little. Like Goldilocks, we like just the right amount of money. The Fed pretends to give us what we want.

And here is where ideology comes in. The conservative school of thought sees the world as being very complicated and uncertain. The right amount of money is no easy thing to attain. Jim suddenly needs money to fix his roof. Dan swears money off when he decides to live in the forest. Imagine figuring out the right amount of money for a whole country day by day. Humbly, conservatives prefer a passive approach. Transactions usually grow by about 5% per year. So let the money supply grow by 5%. End of story. Go fishing.

But liberals always think they know more and apparently they are nervous people who don’t like fishing. They erect giant data collecting machines and try to measure the demand for money on a minute by minute basis. They take great delight and credit by measuring and the ups and downs of money and then trying to match those demand changes with more or less money. Think Whac-a-Mole. Liberals admit that sometimes they get it wrong. They admit that sometimes they even cause recessions when they get it wrong. But alas they are progressives and they are pretty sure that sometime in the future their models will be more correct and the world will be saved. Think Don Quixote.

If the above is not enough to make you reach for the JD pitcher there is more. Even though the infamous JM Keynes said that controlling money was like pushing on a string other modern liberal economists decided to give monetary policy a bigger role in society. Matching money supplied to transactions needs was way too boring for these moderns. So they decided they would match money to employment, prices, exchange rates, and hooker sales. If employment was too low then pump a bunch of money. If prices are too high take it back out. If exchange rates rise then blame China. If hooker sales go up or down call Charlie Sheen.

Talk about a way to guarantee that your name will get into the Bloomington Herald Times on a regular basis. The Fed now has so many balls in the air that it would take a multi-headed hydra to try to catch them all. But undaunted they collect data every day and they have serious discussions and then they go home to their mansions and foreign sports cars.

Yellen and her buddies at the Fed and in the government are not necessarily colluding. They simply have this faith that they know how to manage a 21^st century global economy. That they have been doing it badly never concerns them. They never question this faith that more active policy is better. They are modern and smart. They will learn from their mistakes and finally get it right. They will save us.

Their disease is incurable because failure begets more activism and then more failure. Nowhere in their playbook is taking a deep breath. Nowhere in their training is the idea that too much variance and activism creates uncertainty. Nowhere in their discussions is that it takes time to disentangle short-term noise from long-term trends. Nowhere in their arsenal is the knowledge that some problems are non-monetary in nature and require non-monetary solutions. 

Lackey? I don't think so. Misguided and dangerous? I think so.