The Legend of the Maestro: Never Explain, Never Apologize

The Legend of the Maestro: Never Explain, Never Apologize
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There’s been a quiet revolution in central banking going on for several years now. It’s an ironic turn because the goal of this shift has been to make monetary policies more transparent and open. I’m not sure anyone has really noticed, not yet, and the reasons for this missing appreciation are profound.

The Federal Reserve, for example, has only been holding press conferences for a few years. Though when they started back in April 2011 it was given mainstream attention, I’m not sure most people could tell the difference. It’s not as if Ben Bernanke was some obscure figure before; nor had his predecessors been back to Paul Volcker. Alan Greenspan completed four terms as Fed Chair being constantly on TV.

Yet, it was Greenspan’s Fed where intentional opacity had achieved its zenith. We cannot make the mistake of not distinguishing when someone talks and when that same person actually says something. Though he was everywhere in the popular media, the “maestro” perfected the art of obfuscation. As he once famously said with particularly unusual clarity, “If I seem unduly clear to you, you must have misunderstood what I said.”

That Fed is not this one. Under Bernanke, fedspeak, as it came to called, would be dismantled in favor of more openness and honesty. As Chairman, he worked on it as a legacy project, letting the public in as much as possible about the major policy components. Bastardizing the concept of forward guidance, the central bank now seeks to let the markets know what it will do long before it does it.

This is quite a radical departure from the previously prevailing methodology perhaps best, and most succinctly, described by Montagu Norman. The long-ago Governor for the Bank of England had once asserted that a central banker should, “never explain, never apologize.” Monetary policy operated in stealth.

There are several issues defining these two very different views. Like everything else, the history of central banking on the topic is not linear but circular. Openness was once the operating paradigm for them prior to the early 20th century. None other than Walter Bagehot, the man given credit for laying out the foundations for these institutions, at the very start of his most famous work extols the virtues of clear public delineation on such seemingly complex issues as money markets.

“I venture to call this Essay ‘Lombard Street,’ and not the ‘Money Market,’ or any such phrase, because I wish to deal, and to show that I mean to deal, with concrete realities. A notion prevails that the Money Market is something so impalpable that it can only be spoken of in very abstract words, and that therefore books on it must always be exceedingly difficult. But I maintain that the Money Market is as concrete and real as anything else; that it can be described in as plain words; that it is the writer’s fault if what he says is not clear.”

If someone does not plainly understand what a central bank does, or why it does it, that person will inevitably fill in his own assumptions. That’s not much of a problem when things are overall going well, or very well. That was, in fact, a lot of the emphasis behind fedspeak during the Great “Moderation.” If everyone believed the Fed was the master of the moderate, then did it really matter if it wasn’t?

Greenspan’s elusiveness served to perpetuate the myths of an all-powerful, nearly omniscient technocracy capable of (only) immensely great things. If he spoke more clearly in general, as he did for isolated cases, people might have instead come to very different conclusions, particularly about money, markets, and money markets.

“As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition.”

That the “maestro” said in private, in official deliberation of ending one element of public facing monetary policy. The Full Employment and Balanced Growth Act of 1978 (colloquially Humphrey-Hawkins) required the central bank to produce money targets. Even Congress (Congress!) knew by the late seventies that there was a direct link between money and economy, or more appropriately monetary mess and economic mess.

Rather than tell the public that the Fed supported the sunsetting of provisions in Humphrey-Hawkins with regard to money targets, and more so why, as Greenspan stated forthrightly in private, the Fed would carry on in secrecy lest they let anyone in on their monetary difficulties. At the time it seemed like a small issue anyway, largely because the Fed had by June 2000 come to believe in its own press.

One wonders what might have happened had the Fed been more committed to openness.  There is simply no way to go back and run reasonable counterfactuals, so all we have are inferences.

The big issue of the day in June 2000 was, of course, the dot-com bubble. No one could agree that there was a bubble (even today some people deny it), and furthermore what it would have been that monetary policy might do in response. At the Kansas City Fed’s Jackson Hole conference held in August 1999, Ben Bernanke had argued that even if stocks were in a bubble, it wasn’t a big deal because (I’m paraphrasing) everyone believed in the Fed and so any fallout from it would be easily contained. That hypothesis would in the future be tested with the word “contained.”

Alan Greenspan was at that conference, too. He was a bit more pragmatic in thinking through all the difficulties, starting with the idea of a bubble in the first place.

“Collapsing confidence is generally described as a bursting bubble, an event incontrovertibly evident only in retrospect. To anticipate a bubble about to burst requires the forecast of a plunge in the prices of assets previously set by the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific companies that make up our broad stock price indexes.”

It's an efficient market sentiment that doesn’t hold up so well in light of the monetary and financial history of the 21st century so far. The atrocious economic circumstances of the new millennium are a direct economic consequence, establishing yet again that Congress got some of it right in 1978.

This is not to say any of this is easy. Greenspan was absolutely correct in pointing out that it all seems so only in hindsight.

It’s a proposition that has plagued central banking since the very start. It has become a dirty word, and whenever used it immediately conjures nothing but the negative impressions. We all are taught to hate and blame the speculators.

That’s entirely unhelpful not the least of which because capitalism is at its root a speculation-based system. Risk is at the center of all progress. Without speculation, there would be none taken, or so little of it that potential economic growth would never achieve a sufficient upper boundary to keep the system in place. Social and political breakdown are the consequences, and it’s this problem that we deal with currently.

It would seem logical, then, to distinguish between “good” speculation and “bad” speculation. And that’s exactly what the banking system itself was meant for. Its primary role in a capitalist economy was as intermediation. In that role it meant achieving a level of information, insight, and technical competence that could do just that. Banks would never be perfect, of course, but they could greatly help define and shape the invisible hand as it pertained to money, risk, and reward.

That brings us back to Walter Bagehot and specifically his dictum. Lend freely at high rates on good collateral. The idea was blazingly simple and in many ways elegant, too. As he also wrote in Lombard Street:

“Fourthly. Mr. Hankey should have observed that, as has been explained, in most panics, the principal use of a ‘banking reserve’ is not to advance to bankers; the largest amount is almost always advanced to the mercantile public and to bill-brokers. But the point is, that by our system all extra pressure is thrown upon the Bank of England. In the worst part of the crisis of 1866, 50,000l. “fresh money” could not be borrowed, even on the best security – even on Consols – except at the Bank of England. There was no other lender to new borrowers.”

If banks had good collateral, they had done their job in intermediating speculation of all kinds. If they had done a poor job, they would not have had the collateral to survive, and thus would have been expunged from the system, a direct benefit to it.  But what did he mean by collateral?

Any use of the word in today’s money markets immediately brings up repo. That’s not what Bagehot was talking about, however, and this is no small point. In 19th century England, financial collateral wasn’t just some bond security, government or otherwise. It was in almost every instance what was called a “real bill.” That was, after all, the very thing, the only thing, central banks were discounting and using for their monetary policies.

A real bill was nothing more than a financial instrument tied purposefully and directly to an economic act. A bankers’ acceptance qualified as a real bill in that there was a shipment of goods in existence that required only the monetary means to complete. A steamship full of US agricultural produce leaving the vast stockyards of Chicago, for instance, financed by a bill as it headed for the East Coast via railroad was “good” collateral. Contained in that category, because it was included already in the real economy, was the “good” form of speculation.

A bond issued by the railroad to finance prospective future tracks was not, even if it was issued by the best quality railroad of the time. The bond was purely speculative, in Bagehot’s framing, while the bill was what mattered in keeping to monetary terms. Not that there was no use for the former.

Read again the passage I quoted above, particularly his reference to “bank reserves.”  Bagehot writes specifically that, “the principal use of a ‘banking reserve’ is not to advance to bankers.” It is supposed to, in the end, like the good collateral of real bills, directly support the mercantilist ventures of that system. All these things relate first and foremost to the real economy. Even the banking system itself is a secondary approach upon that primary task.

In short, good collateral was all the instruments drawn up from what was actually happening. In that way, the real economy itself, not speculation about what tomorrow’s economy might be, was the foundation for value, therefore liquidity, therefore intermediation at its best, and worst.

This is not how the modern system is set up; at all. It has become instead a convoluted mess whereby no one is really sure what happens between A and B, but in the legend of Alan Greenspan monetary policy has some predictable effect on economic outcomes even if monetary policymakers really don’t know how or why. It really strains the word “predictable.”

The good news is that in striking for more transparency, central banks are really showing their weaknesses first and foremost. They may not think it a pleasant experience (and they haven’t seen anything yet), but make no mistake it’s a necessary one.

In January 2012, the FOMC voted to make explicit one of those previously hidden parts of policy decision-making. It wasn’t a huge change, as everyone knew all along the Fed as other central banks was targeting 2% inflation (PCE Deflator) as its definition of price stability according to its Congressional mandates. In the policy meeting that month when the vote was taken, only one Fed member, Daniel Tarullo, voiced any substantial concerns. From the just-released 2012 FOMC transcripts:

“MR. TARULLO   You [Chairman Bernanke] seem to indicate that it was basically setting down as best we could what we think we currently do within this Committee… I should state for the record why I can’t support the document, and because it comes down to the same thing I’ve said before, I won’t say it at great length. I think the document has made vagueness a virtue to an excessive degree, and there’s a nontrivial risk that what comes out of this will actually be more of a cacophony than a clarification.”

How can a commitment to greater transparency in the form of more openness on a policy level contribute to instead to “vagueness” as Tarullo warned?  The answer is the inflation history of the last six years in between. Almost from the moment of their declaration, the deflator has undershot the target (missing in 66 out of the last 68 months), often substantially and in the mainstream “unexpectedly.” If they can’t achieve their inflation target after six years of massive interventions, what the hell are they doing?

To try and answer that question, the FOMC and Janet Yellen in particular have been left to increasingly ridiculous and absurd explanations, as well as the occasional suggested policy tinkering (raise the inflation target to 4%!). They have used the word “transitory” year after year after year so that by 2018 it has lost all its meaning forever forward. Transitory is now defined in Washington as any length of time up to and including an infinite one where the Fed fails to live up to its transparent goals, but doesn’t have to admit it or why.


And here’s one more part of it. The economy won’t grow, but the stock market sure does. What speculative pieces might be encouraged by malfunctioning intermediation caused by interpretations of a monetary system no one really understands?

In many ways, we are back in 1999 wondering about, “the prices of assets previously set by the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific companies that make up our broad stock price indexes.” The efficient market hypothesis, other than being born out of mathematical necessity, rests upon on the idea of dispersed knowledge (the concept behind Big Data). There is a lot of truth to it.

But we also have to account for periods where knowledge and information might not be so decentralized. I’ll put it another way: Where do most people get their economic forecasts?  Central banks and especially their econometric models are behind all of it. This is not a statement of hyperbole, a direct consequence of fedspeak hiding the truth.

If “everyone” is using the same general outlook about the background economic circumstances of the future, how widely decentralized is the information behind stock prices? That’s especially the question if those “highly knowledgeable about the prospects for specific companies” base those prospects in significant part upon the forecasts of Economists who the highly knowledgeable believe are likewise highly knowledgeable if about the economy rather than companies. Economic projections are not some trivial concept in this area.

Assuming that’s all true, the consequences would be in the form of unappreciated risk, the type of speculation that has haunted monetary and financial systems from the get-go. It in many ways answers to the argument about “good” collateral, the economy that is versus the speculative one that “will be.” A systemic framework where there is no such thing (the closest we can come up with are UST’s) is one susceptible, in theory, to the corruption of centralized viewpoints (what was it that led the system to believe AAA MBS of any kind was not just as good as a UST or as good as gold, but for quite a long time better than either?)

Maybe there is no stock bubble this time, perhaps economists and central bankers have it right for once. That’s one reason why the inflation debate is so important. Consumers and businesses aren’t suffering because the PCE Deflator has averaged 1.3% since January 2012 instead of 2%. What that represents is downside risks the central bank hasn’t been able to successfully manage – or even forecast.

Indeed, the PCE Deflator going back to December 2008 has averaged the same 1.3%. The common theme over those last nine years is nothing but the downside. Record high stock prices are an expectation for a final end to it.

We still, however, have to live with, and on, collateral, or what’s left after private lending spent a very long time infatuated almost exclusively with the “bad” form of it. Because of that, there has been a zombie-like focus on only the most liquid versions at the expense of “good” collateral formation. I’m not saying a strict real bills doctrine would have been the answer, only that the pendulum swung way too far in the other direction. Intermediaries stopped doing their job. They stopped purposefully discerning the “good” speculation from the “bad”, at least to such a degree that it has led to a screeching halt in the global economy now for a whole decade. Why did they change in their focus on risk?


The legend of the maestro. Never explain, never apologize. Only now, there is so much to explain and apologize for. In Bernanke’s purposeful spirit of openness, inflation would be a good start. Perhaps bubbles, too. Finally, if we can last that far, all that’s important about collateral.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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