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The Anguish of Central Bankers

November 12, 2005

It's been more than twenty-five years, since former US central bank chairman Arthur Burns was at the meeting of the International Monetary Fund in Belgrade (September 30, 1979) where he made his famous speech entitled "The Anguish of Central Banking". In his talk Burns offered little hope for an escape from secular inflation. "Current worldwide philosophical and political trends will continue to undermine wealth creation and strangle incentives. These modern trends produce permanent budget deficits and have introduced a strong inflationary bias into the economy".

Reviewing central bank action in the 1960s and 1970s, Burns stated in his speech that "Viewed in the abstract, the Federal Reserve System had the power to abort the inflation at its incipient stage fifteen years ago (1965) or at any later point, and it has the power to end it today. At any time within that period, it could have restricted money supply and created sufficient strains in the financial and industrial markets to terminate inflation with little delay. It did not do so because the Federal Reserve was itself caught up in the philosophic and political currents that were transforming American life and culture" into a "FULL Employment Economy" which is incompatiblewith fighting inflation in a consistent way. They may try to curb the inflationary pressure, but, "by and large", monetary policy has fallen under the spell of being "governed by the principle of under-nourishing the inflationary process while still accommodating a good part of the pressures in the political marketplace", It is the same in other parts of the world where almost all of the modern central banks are functioning in a basically similar political environment, and thus behave in the same fashion leading to the "anguish of central banking" Central banks are not only hostages of their political environment, but they are also technically and intellectually hardly up to their job. Central bankers make errors and encounter surprises "at practically every stage of the process of making monetary policy"; misinterpretations of statistics abound, and there is also no reliable scientific guide for central banking: "Monetary theory is a controversial area. It does not provide central bankers with one set of decision rules that are at once firm and dependable."

Burns ended his speech saying: "My conclusion that it is illusory to expect central banks to put an end to the inflation that now afflicts the industrial democracies does not mean that central banks are incapable of stabilizing actions; it simply means that their practical capacity for curbing inflation that is continually driven by political forces is limited"

Has anything changed since then? Are central banks up to their job by now? Have they learned how to interpret statistics correctly? Have they gained true independence? A superficial answer may say yes: Paul Volcker came in, put on the brakes, wiped out inflationary expectations and opened the door to decades of stability. And then along came Alan Greenspan to carry on. In a more realistic assessment, however, the answer must be that not much has really changed. Inflation seems to be more benign nowadays, but it is a harsh twist of words to say price stability has been achieved when, since 1980, the official price index has doubled. Central bankers still meet surprises "at practically every stage of the process of making monetary policy", modern interventionist academic monetary theory has actually contributed very little "to provide central bankers with decision rules that are at once firm and dependable".

Seen in a long-term historical perspective, we still live in an inflationary age. The turning point for the U.S. can be clearly defined as 1914 when the US central bank began its operations. It took only a couple of years for the newly created Federal Reserve System to create an inflationary boom ushering in the way to the Great Depression later on. The "stability" of the 1930s and 1940s came about due to the Great Depression and the price controls during the war. After that episode, prices began their steady rise, first slowly, then, since the early 1970's, much more accelerated. In a long-term perspective, the deceleration of the price increases in the 1980s followed by their stabilization into the late 1990s seems nothing more than a slight flattening of the curve and then only if we assume that the Stock Market, Bond Market, Real Estate and Commodity Bubbles have nothing to do with inflation.

Since the abandonment of the gold standard, we have entrust two of the most important prices in the economy -- the interest rate and the exchange rate -- to governmental bureaucrats for them to manipulate. Presumably they know what they are doing and they are doing their best for the country (Typical elitist socialist thinking, they know what's best for all us stupid people) Facts speak against this presumption. After a short period of forcefully curbing the money supply in the late 70s early 80's - due more to the effects of a crashing US Dollar and necessity to support it, than by deliberate design -- the US central bank has turned once again into veritable debt machine inundating households, companies, government and the globe with debt and dollars. Foreign central banks and governments are eager to join in, each of them attempting to gain an advantage by targeting the United States as the willing absorber of its exports as well as allowing governments to live beyond their means. What is going on currently is global debt creation at an unprecedented pace, and the major players in this game are central banks under the obvious or implicit instructions of their governments.

Registered inflation rates have been manipulated and seem more subdued since the 1980s, but inflation certainly is not "dead" and the inflationary age has not yet ended, and it will not end as long as central banks and governments hold the lever to create money at will. No less so than when Burns practiced central banking, the interventionist policies of today's central banks lack a reliable basis in monetary theory, diagnostic errors abound, and the inherent inflationary bias of central banks is still rampant. While seemingly recently benign, inflation will turn up with abandon in the very near future as it expands out of its confinement to financial assets and real estate into the general market place. In this perspective, it seems an idle game to expect better central bankers or improved analytical tools or more reliable econometric models.

Bernanke can talk all he wants to about targeting inflation but until he realizes that there are 12 to 36 month lag effects to all Government policies and central bank actions, and then devises a set of signals that can tell him what to do; then all we will be getting is a lot more of the same. Credit expansion is all (including Republicans) socialistic leaning government's foremost tool in their struggle against the free market economy: It's is the magic wand to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish altogether any restrictions on lavish government spending; by expropriating the capitalists or more correctly all the SAVERS, to contrive everlasting booms, and to make everybody prosperous" -- with the consequence that such an artificial boom, must eventually lead to a big bust. Modern central banks politically can do very little, at best they can try to mitigate the unrelenting trend towards inflation -- they are seemingly only good at their job when helped by some luck. Faced with the choice between putting serious strain on the financial markets by terminating inflation or letting the boom go with the risk of inflation getting out of control, they will opt for the latter. at least until the next President is elected. In the current institutional setting it is the natural tendency of central banks to produce unsustainable booms first and then try to mitigate the inevitable slump. But prolonging (postponing) is the best that they can do, they cannot eliminate the inevitable, but in doing so they always end up exacerbating the size and duration of the ensuing correction or crash. It's not a question of "IF" but "WHEN" the next crash will come.


Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]


12 November 2005

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