Central Bankers Can't Even Get the Small Things Right

Central Bankers Can't Even Get the Small Things Right
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We all know why governments would love nothing more than to print money. I’m not talking about the figurative kind, either; the inert byproducts of modern central bank large scale asset purchases. Those bank reserves aren’t it. I mean the real thing, physical currency. The very stuff Milton Friedman once dreamed about dropping from a helicopter.

Monetary constraint has always bedeviled officials tending toward the profligate. Nobody likes to live within a budget, those making decisions with other people’s money least of all. If taxpayers won’t pay more taxes, the desire to simply conjure the funds out of thin air never really goes away no matter how many historical examples prove the folly.

Is there, however, any circumstance where governments would go the other way, as in, to stop printing? And I don’t mean cease printing long after they’ve started the hyperinflation express. Instead, I’m thinking about a situation where a government or central bank that is acting otherwise normal and consistent with past experience just decides one day to reduce currency growth down to nothing.

There is no inflation problem, consumer prices are well under control. If anything, the domestic economy is acting lethargic already. Why in the world would somebody read that situation and declare less currency the goal?

This, by the way, isn’t a hypothetical. It is China in 2018. And it’s not the Chinese’ first brush with the anti-printing press. Their central bank, the People’s Bank of China (PBOC), made a similar decision in, you guessed it, 2015.

Currency as a matter of Central Government policy is lumpy to begin with. Toward the end of the 20th century the Communists always in pursuit of inhuman sameness (which is very different than equality) harmonized the vacation schedule for Chinese workers. There would be three weeklong holidays each year; the first at China’s New Year in January or February; the second connected with May Day; the last in early October to celebrate Mao’s victory and the birth of the People’s unrepublican Republic.

As an economic matter, these Golden Weeks were forecast to boost consumption. Workers with more time off would spend and travel, more foreign tourists, too. Economists whether Western or Communist always believe that changing some arbitrary constraint is the key to increased growth.

Instead, the Golden Weeks became a burden, an enormous hassle. By December 2007, the middle one was quietly being eliminated. Though Communists love May Day, China’s Communists decided that the only way to proceed if with two was to make sure they were spread as far apart as possible.

In terms of banks and money, the former end up hoarding the latter in anticipation of being shutdown and closed for a week at a time each time. In response, the PBOC actually prints currency beforehand, and then pulls it back afterward.

The amounts are often staggering. At the end of December 2017, the central bank’s balance sheet showed RMB 7.7 trillion in currency outstanding. The following month, January, as banks began to hoard liquidity and shoppers increased their holdings of cash the PBOC upped currency outstanding to RMB 8.2 trillion. With the New Year being late in the middle of February, the balance for that month ballooned to RMB 9.1 trillion. By the end of March, the central bank brought it back down to RMB 7.9 trillion. This is China’s typical seasonal pattern.

And it is actually how a central bank is supposed to operate. This is what they are for, not some convoluted economic policy of “stimulus” or “accommodation.” Money is an economic tool and its distribution, or supply, can greatly affect economic conditions. The real modern stupidity is the central bank conceit that it can intentionally alter those conditions by making non-economic decisions about money – more often than not based entirely on regressed statistical correlations of long ago past circumstances.

What the Chinese central bank does for their Golden Weeks is what Western central banks used to do as their main focus. Even the Federal Reserve’s first task was smoothing out the dollar money supply around Christmas. In 1805, the Bank of England installed a weather vane on the main building’s roof, with a dial in the bank’s boardroom quite purposefully attached to it. Judging the prevailing wind was serious business because Britain’s entire economy ran on trade.

From the Financial Times:

“If the wind was coming from the east, ships would soon be sailing up the Thames to unload goods in London. The Bank would need to supply lots of money, so traders could buy the wares landed at the docks. If a westerly was blowing, the Bank would mop up any excess money issued to stop too much money chasing too few goods, thereby avoiding inflation.”

The supply of money needs to be reasonably attached to the demand for it. That’s what interest rates used to be about before central banks left the money business for Economics.

The People’s Bank of China is caught today in the middle between. It is still in the money business but would love to join its Western cousins doing whatever it is they do. The Chinese economy needs currency.

And the PBOC isn’t supplying much of it this year. For the month of August, the latest figures available, the amount of currency outstanding was just 2.6% more than in August 2017. This lack of money growth is unrelated to Golden Weeks, either one. The Chinese haven’t stopped the printing press, but they’ve slowed it way down to almost being halted. This is highly unusual.

So far this year, RMB physical currency is growing by an average of just 2.7%, including those wild swings around China’s New Year. In 2017, growth had averaged 6.6%, the same as in 2014 when CNY first began to tumble (the other side of the “dollar’s” rise). In 2012 and 2013, currency growth was about 10% each year, and in 2010 and 2011, 15% and 16%, respectively. In 2008 and 2009, both somewhat rough years for the PBOC, it still managed currency expansion of about 13% in both.

The only time Chinese currency had grown as weakly as it has so far this year was during 2015 (3.2%).

Why have the Chinese stopped printing their money? Let’s ask the Germans.

Back in January, the German government was in a rush. Chancellor Angela Merkel’s Christian Democratic Union/Christian Social Union had suffered a humiliating electoral rebuke the prior year in September. Though the CDU/CSU had won the largest voting share, its support had dropped precipitously in favor of the “hard right” Alternative for Germany (AfD). This latter group had never polled high enough to enter the Bundestag, but after September 2017 it would be Germany’s third largest bloc.

The “establishment” became alarmed. If it could happen in Germany…

To demonstrate the illegitimacy of these populists, officials everywhere have clung to economic success, really distorted perceptions about it. If there is no economic excuse for these electoral results, then the often migrant-centered focus of populists can be dissolved into some form of “ism”, either racism, xenophobia, or whatever.

On January 29 this year, Merkel’s government raised its economic projections for Germany in 2018. Her economy had been, she claimed, booming in 2017 and by all outward appearances it seemed reasonable to expect it would continue. Previously, Economists were forecasting 1.9% growth but quickly upped it to 2.4% after a supposedly strong finish to the prior year. As Reutersnoted on that date, “The revision follows a string of bullish economic data that showed Europe’s largest economy is still firing on all cylinders after posting its strongest growth rate last year since 2011.”

January 29 was a particularly interesting day for them to do this, the first day of global stock market liquidations that stunned the world.

Yesterday, some widely followed private economic forecasters did it again, though this time by raising a related alarm. Economist Roland Doehrn of RWI was widely quoted throughout the global media when he said, “the upswing of the German economy is losing momentum.” GDP growth has been cut to 1.7% for 2018.

Economic growth has already stalled in Germany. In 2017, the economy there had managed nearly 3% for the year, the best in a long time all the way back to 2010. It started out near 5% in the first quarter of 2017. Even in the final two, GDP was expanding by 2.1% and 2.5%. In Q1 2018? Just 1.4%.

Practically everyone in the mainstream will tell you this is all Trump’s fault. Trade wars are starting to take a toll on especially global trade, which Germany’s economy is particularly sensitive about. Not even Economists are so sure. Protectionism is often cited but as one possible factor among others, several of which are just nuts (and show that Economists aren’t really sure). One of those accompanying every article in which Dr. Doehrn was quoted was Italian debt concerns.

That’s what’s driving Argentina’s massive dollar drain? Or Brazil’s looming re-recession after 2014-16’s absolute catastrophe? And now India’s record lows for the rupee, pegged to worries about how Italy’s Finance Minister Giovanni Tria will conduct himself in office?

Either the global economy is strong and therefore the populists have no cause, or now that the global economy appears much less certain the populists (Trump being one) are to blame for what are being reluctantly recognized as serious downside risks. How convenient. And predictable.

Germany’s plight is the same as China’s, and not just in terms of hindered trade prospects. The Chinese central bank won’t print currency because it can’t print currency. The next eurodollar squeeze is on and it is pulling the global economy apart for a fourth time.

It hits China hard because “dollars” are central to the monetary basis for renminbi. Foreign exchange “reserves” are the bulk of the PBOC’s assets, and therefore the main backing, in the modern sense, for its domestic currency. Since 2013 when the Chinese finally became intimately acquainted with the eurodollar’s deflationary wave, the second one in 2011, there just aren’t enough “dollars” to supply China’s monetary base.

It’s not all at once, of course, the last major squeeze registering its full effects in 2015. Alongside practically no growth in currency that year the PBOC also opted to allow bank reserves to outright contract, sharply. It was a disaster and it wasn’t, obviously, limited to the just China or even Asia.

If there aren’t enough “dollars” for China there aren’t enough for Germany, or for Germany’s trade partners. They’re starting to notice. This is the modern equivalent of the Bank of England’s weather vane, only there isn’t a single central banker paying attention to it.

They are all too busy playing the game of politics. Or fussing on some blackboard over “a parameter truncation criterion developed in conjunction with the new Stein estimator...used in an orthonormal linear statistical model setting.” I pulled that one from the PhD dissertation of one Yi Gang, who this year was appointed to head up the PBOC.

Yi is the same as all the rest of them, a Western-trained statistician. He obtained his doctorate from the University of Illinois. I don’t know if he’s ever been to visit the Bank of England, but I would bet he wouldn’t have the first clue about what to do with the wind dial.

The People’s Bank of China can handle the monetary bottlenecks that naturally arise from its quirky holiday calendar; they have enough experience. It cannot handle those much larger disruptions in the main global monetary system. These central bankers are technically proficient in their local idiosyncrasies, but if those are a minor issue to the global currency dynamics what good can they do in the end? They can keep the lights on but no more than that. And even that’s more and more in doubt (CNY this year).

It’s still an order of magnitude better than their Western counterparts who struggle just on the basics. Here in the US, the Federal Reserve can’t manage to manage federal funds even though its target of that particular money market has (hypothetically) formed the basis of its monetary policy for decades. Federal funds instead embarrassingly rebelled at the worst times, in 2007 and 2008, and is doing it again right now this week (now only 2 bps below IOER).

I won’t even list the European money markets because it would take too long to go through all the blatant distortions.

I’m in danger of committing a logical fallacy but the evidence is strong enough to assert that if they can’t get the small things right there is little to no chance they get the big ones. In truth, the reason central bankers struggle on the small things is that one giant thing. The eurodollar doesn’t appear even once in the Financial Crisis Inquiry Commission’s official report on 2008, but it is everywhere still in 2018.

Actually, I take that back. It isn’t enough anywhere in 2018. Again.

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

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