Recital by Alice to the Caterpillar in:
TALES FROM ALICE IN WONDERLAND
By Lewis Carroll

Reading this paper was a chilling reminder of just how fragile liberty truly is. The Federal Reserve Board publication persuades to be forward looking. It is not! The body consist of reviews and "empirical" evidence of successfully implemented strategies on a brainwashed investment public. You will find little of what is discussed or proposed that has not been implemented or is not in the process of being implemented when one matches the report with past and current economic activity.

Any government, as an economic being, acts like a parasite. It does not produce goods or services through the productive process of capital formation nor is it subject to the harsh discipline of profitability. Analysing a government's behaviour in this context requires an understanding that governments follow self-serving policies. Recessions or worst, depressions will be counteracted with constant stimulation of aggregate demand. It loath to reduce in size, in fact, it is quite incapable of reducing its own size. Primary saving is beyond any government; it can only repay its debt or hoard from what it has confiscated. It's significant economic weakness is being too successful in serving its own needs. Extreme government objectives will thus entail, stimulating the economy even beyond where the economy goes into systemic shock; maximise taxation to the point of resistance; encourage excessive private debt and maximise public debt, then create as much money as the economy can absorb; and if you are in the fortunate position of having a reserve currency, create as much money as the world economy can absorb. The next step is pro-active endeavours to control the cost of money, i.e. interest rates, especially longer-term interest rates. To achieve all this, actively practice deception upon and mind control over all other economic entities.

Which brings me back to the "staff working paper" published by the Federal Reserve Board. This report contains explicit references to all of the abovementioned objectives of government as expressed via its monetary policy. I have extracted quotes from the report and re-arranged them into a short summary and analysis to substantiate the abovementioned assertions. If you find it surreal like Alice in Wonderland, don't be fooled, it is the reality of how the world is viewed by the executive of the Fed and their advisers.

Economic stimulation is the overriding objective even beyond zero interest rates. "… nominal policy interest rate may become constrained by the zero bound. When that happens, a central bank can no longer stimulate aggregate demand by further interest-rate reductions…"[1] "… a nominal interest rate near zero does not preclude the possibility that real interest rates are too high for the health of the economy."[2] "However, nothing prevents the central bank from adding liquidity to the system beyond what is needed to achieve a policy rate of zero, a policy that is known as quantitative easing."[3] "… sufficiently large monetary injections will materially relieve the government's budget constraint, permitting tax reductions or increases in government spending without increasing public holdings of government debt…". [4] Never stop creating money, even when interest rates falls to zero. The outright proposal is to simply create sufficient money to make up any shortfall in government's monetary resources. It goes even beyond that to suggest creating sufficient money to actually allow tax reductions. There is hardly a role for savings in an economy of zero interest rates and unlimited money creation.

The governments' obvious desire for a growing tax base even when stimulation manifest as inflation in long-lived assets in this case equities, is explicitly expressed. "In the mid-1990s, rapidly rising real incomes and expanding equity values increased both the tax base and the effective tax rate in the United States. The swelling of Treasury tax coffers, combined with some discipline in spending, turned budgetary deficits into surpluses."[5]

These objectives will require direct management of private sector expectations and the question is asked. "How then can a central bank influence private sector expectations?"[6] The paper continues to answer its own question. "Shaping Policy Expectations: Evidence from a Macro-Finance Model of the Term Structure. Our event studies confirm that FOMC statements have important influences, both direct and indirect, on private sector policy expectations."[7] The writers even claim success at sensitising market responses to those variables that the central bank wishes the market to focus on and to detract from undesirable developments. "If FOMC communications are responsible for the increased responsiveness of yields (and the associated policy expectations) to unexpected changes in payroll employment, it should also be the case that markets have responded less to macroeconomic developments not flagged by the Committee as likely to have a strong bearing on policy decisions."[8] It is carefully worded in the negative but translates to; we will tell you what is important and what is not important. Every effort will be made to control the thinking and behavioural patterns of other economic entities.

How did they do it? They used hints, strong hints and for maximum effect surprise the market with an unexpected strong hint. "Investors are most interested in statements that provide hints about the Committee's inclinations regarding future policy actions (as opposed to, for example, statements that describe past economic developments)."[9] "… indicating that statements providing new information about the prospective path of policy have a powerful effect on year-ahead policy expectations and hence, indirectly, on the five-year Treasury yield as well."[10] "Conditioning effects of policy statements. The immediate effects of official FOMC statements on policy expectations likely underestimates the overall impact of FOMC communications on expectations;"[11] It is concluded that the effectiveness of conditioning on market behaviour is underestimated!

It's all about make-believe. Even scare tactics will be employed when needed… "Table 8. Notable events in the 2003 deflation scare."[12] The strategy of persuasion has a questionable moral implication. "By persuading the public that the policy rate will remain low for a longer period than expected, central bankers can reduce long-term rates and provide some impetus to the economy, even if the short-term rate is close to zero. However, for credibility to be maintained, the central bank's commitments must be consistent with the public's understanding of the policymakers' objectives and outlook for the economy."[13] It is an outright objective to also exercise control over long-term interest rates. "Notably, the Federal Reserve has successfully used its communications to affect expectations of future policies and thus longer-term yields."[14] Creating an incorrect anticipation is presented as a successful implementation of the policy of shaping expectations. "Of course, the FOMC never undertook targeted purchases of Treasury securities, but in an efficient market even the (incorrect) anticipation of such an event should affect yields."[15] These techniques to control the market are constantly under review with the aim to increase the effectiveness of control. "A consecutive reading of the statements reveals continual tinkering by the Committee to improve its communications."[16]

The desire to extend control beyond short-term interest rates is expressed in the following quote. "In the United States, at least, the short-term policy rate has little direct effect on private-sector borrowing and investment decisions. Rather, those decisions respond most sensitively to longer-term yields (such as the yields on mortgages and corporate bonds) and to the prices of long-lived assets (such as equities)."[17] Government is the obvious beneficiary of lower longer-term interest rates. The authors perceive control over the interest cost of funding of government as an outright objective. "… the Fed's action might be able to influence term, risk and liquidity premiums - and thus overall yields."[18] The paper bemoans the restrictions on the Fed's direct control over long term yields. "… however, the Federal Reserve is restricted to purchasing a limited range of assets outside the treasury securities…"[19] They, however, suggest that they can actively work towards circumventing the restrictions. "These restrictions might effectively be made less binding by various methods."[20]

It is implied that saving for the future is an outdated concept. Remove term risk, therefore the price of money today and money tomorrow should be the same. Money creation is promoted as if a substitute for savings. The elimination of savings from the economic equation will also allow for the removal of the risk premium on longer-term borrowings. Even more important is that government cost of funds will become very low, allowing government to super boost its borrowing and spending, in much the same way that mortgage borrowers had leveraged themselves, without suffering the consequences of higher interest costs in the national budget (for how long?). This looks like a blueprint for an economy where control over the decisions of economic entities is fair game to government, savings are almost irrelevant, debt overload for all is desirable and unending quantitative easing (printing money) will sustain a banking sector in perpetual systemic failure. I somehow think that future generations will not saviour such an inheritance.

In Zeroland, as in Wonderland, nothing works as it should and your mind is not your own.

Sarel Oberholster
Bcom (Cum Laude), CAIB (SA).
1 November 2004
E-mail - ccpt@iafrica.com

All the quotes are from: "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment" by Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack 2004-48.

1. Authors page, extract from "ABSTRACT"
2. p. 8.
3. p. 17.
4. p. 20.
5. p. 57.
6. p. 10.
7. p. 47.
8. p. 46.
9. p. 41.
10. p. 43.
11. p. 44.
12. Table 8 after p. 64.
13. p. 81.
14. p. 80.
15. p. 63.
16. p. 33.
17. p. 9.
18. p. 24.
19. p. 25.
20. p. 25.