Wednesday 8 November 2017

The Reserve Bank is already less responsible than you think


The new Labour-Green-WinstonFirst Government intends to "review and reform the Reserve Bank Act," says Hard Labour's Grant Robertson, expanding the Bank's parameters to deal with more than just its present single-issue focus of inflation. They want it also to focus on things like employment and exchange rates (to which short list others like economist Ganesh Nana would also add happiness, sustainability, and the production of rainbows and unicorns.)

"Bad move," say opponents of the move, criticising both the loss of focus and the Bank's inevitable politicisation. They cite, as Don Brash did on radio this morning, the "incredible" record the Reserve Bank (and other central banks around the world) have maintained in the last two decades in "fighting inflation." Take the hand of the one tiller, they say, and this great record with be destroyed and prices will quickly run amok!

This ignores a great deal.

It's true that a focus on using monetary policy to focus on "employment" for example is an invitation to use the Bank's interest-rate manipulation for political ends. But the claim that central banks have been great at using their control over paper currency to "fight inflation" these last few decades should be seen for the illusion it really is: one need only look at the asset-price inflation in housing (both here and worldwide) and in stock markets (both here and worldwide) to understand what the last decade of historically-low interest rates has done to destroy genuine price and capital formation.

And we should also understand the "role of the average" in measuring the success of their present inflation target -- meaning that averages are not always descriptive: two diners, two steak dinners , for example ... but if one diner eats both, our a"average"leaves us blind.

So it is today, with the more government-laden parts of economies heading for the price stratosphere ... the "average" price inflation targeted by central banks being made to look good by the incredible performance of the less-constrained sectors.


US FIGURES,  with 1996 as the base -- but expect to see the same
sort of spread in every western welfare state with a central bank


This is really the real story of the last few decades, explains Deutsche Bank's Jim Reid, who "contends that the fiat currency system 'is inherently unstable and prone to high inflation'." High price-inflation that has been effectively hidden in plain sight by the rapidly-falling prices generated

by China's rapid economic emergence in the 1970s, and [by] an explosion in the global working-age population, [which] have allowed inflation to be controlled externally.

But that period is also historically unprecedented, he points out.

And that period is now coming to an end.

Reid's basic contention is this: The dominance of the fiat currency system since Richard Nixon decoupled gold from the dollar in 1971 "is inherently unstable and prone to high inflation," and an offsetting disinflationary shock that kept it afloat since 1980 is now slowly reversing.
    If that's the case, Reid says the fiat currency system — a term which describes any currency whose value is backed by the government that issued it, rather than by a commodity like gold or silver — could be "seriously tested" over the next decade.
Disinflationary forces    The basis of Reid's argument is that China's rapid economic emergence in the 1970s, and an explosion in the global working-age population, has allowed inflation to be controlled externally, because a boost in labour supply during a period of globalisation naturally suppressed wages.
    Externally-controlled inflation means policy-makers and central banks can respond with familiar tools: More leverage, loose policy, and extensive money-printing.
"It's not usually this easy as inflation would have normally increased with such stimulus and credit creation," says Reid. In fact, "it could be argued that this external disinflation shock has perhaps 'saved' fiat currencies."
An end to the demographic super-cycle    If this theory is correct, Reid says, then "any reversals in this demographic super cycle could spell problems for the fiat currency system."
    Under that scenario, inflation would pick up externally as the working-age population stopped rising and labour pricing power returned, as demand rose and supply shortened.
    Reid continues:

"Central banks and governments which have ‘dined out’ on the 35 year secular, structural decline in inflation are not able to prevent it rising as raising interest rates to suitable levels would risk serious economic contraction given the huge debt burden economies face.
    As such they are forced to prioritise low interest rates and nominal growth over inflation control which could herald in the beginning of the end of the global fiat currency system that begun with the abandonment of Bretton Woods back in 1971."

After fiat currency
Eventually, Reid says, "it’s possible that inflation becomes more and more uncontrollable and the era of fiat currencies looks vulnerable as people lose faith in paper money."
I think Reid's basic premise is unarguable.

What then for the Reserve Bank Act's central illusion?

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