The Monetary Circus of Today Is Real, And It's Legal
You can always tell what won’t happen by the way in which Congress titles its laws. In March 1980, President Carter was fighting for re-election. While the Soviets had invaded Afghanistan in December ’79 and Muslim revolutionaries had seized the US embassy in Iran in January ’80 taking 52 Americans hostage in the process, the key to Carter’s electoral fortunes was much closer to home, tied directly to America’s economic prospects.
At the time, 1980, the Great Inflation was mostly what mattered. After a decade and a half had been burned by incompetence at all levels, finally the politicians decided they’d intervene on behalf of their bunglers the Economists. Particularly those at the central bank.
That’s why on March 31, 1980, President Carter signed into law the country’s most audacious banking changes since the Great Depression.
Officially the law is titled the Depository Institutions Deregulation and Monetary Control Act, but mostly it’s been known in history as simply the Monetary Control Act of 1980. As I said, you can tell what isn’t likely to occur by the name they slap on to these things.
Very little monetary control from that point forward, there has been, at least, a whole lot of acting. If Congress has to step in and tell you, point blank, to do your job it’s about the worst performance review imaginable. Congress!
But, the central bankers protested, it wasn’t our fault!
According to this group, America’s elected representatives needed to blame instead the Great Depression. Or, if not predisposed to shouting obscenities at inanimate prior periods in history, everyone needed to consider the laws which were developed during that era. Primary among them Regulation Q which had, for reasons that don’t stand up to history (financial and monetary illiteracy in official circles is immemorial), put a ceiling on the rate banks could pay for customer deposits.
Not much problem during the thirties and forties when business opportunities were low and tight (not loose) monetary conditions reigned supreme, but in the growing and globalizing economies of the fifties and sixties there was money to be made. Especially in out-of-control money.
The government can and often does mandate a great many silly things, compliance to which requires active approval of the governed. As it pertained to Regulation Q, once the deposit ceiling got in the way of business, businesses weren’t so willing to be compliant. If banks weren’t going to pay them a going rate for their cash, businesses would seek out anyone who could.
For one thing, the growing ranks of multi-national companies had at their disposal an offshore dollar market which, since it was outside the United States, would not be subject to Regulation Q or any other domestic regulation. The increasing need for global dollars met perfectly the increased willingness of monied interests to supply them.
Apart from these eurodollars, companies as well as wealthy individuals could turn to non-banks and even other forms of monetary exchange. We don’t really know exactly when the market for repurchase agreements became this primary method, where banks would conduct repo trades on behalf of their regulation-busting customers with securities firms by acting as a brokerage agent rather than a traditional depository.
Either way, and it didn’t happen overnight or all at once, once those bank customers began writing checks and drawing drafts against their market-rate-paying repo balances, repo money became effective real money even though it didn’t count in any official definition. Outside the Fed’s control and right under its nose, the M’s rendered obsolete by what was deemed forever prudent practice in the early thirties.
Ours is a dynamic world that never stands so still. Even when change seems small and incremental in the short run, over time it still can add up to something revolutionary.
In one sense, the Monetary Control Act of 1980 was the politicians listening to the central bankers, acceding to the explanation that monetary evolution was a crucial factor in making the Great Inflation. Title I basically broadened the Fed’s authority by bringing some of these non-bank activities and vehicles under its jurisdiction (reserve requirements, mainly).
But it was also an admonishment in the sense of, why did it take you so long to say something about this? After fifteen years and senseless financial inflationary ruin, once the finger was pointed squarely on them only then did the central bankers meekly say, oh, by the way, there’s all this non-bank money stuff…
Part of the reason they did was because monetary authorities were caught red-handed. On March 24, 1975, the House of Representatives had passed Concurrent Resolution 133 which began by stating all monetary authority, duly designated, arises from Article 1, Section 8 of the Constitution which hands Congress sole authority to coin money.
From there, Congress established the Federal Reserve as its agent and delegated to it “the day-to-day responsibility for managing the money supply” but that said delegation wasn’t acting in a responsible manner. The United States “suffering from excessively high unemployment and a decline in production and the gross national product, together with inflation” that was being caused “in part” by “changes in the rate of growth of the monetary and credit aggregates.”
Eurodollars were on the minds of those in Congress back then. To try and fix the Fed’s mess, the House concurrent resolution (meaning the Senate concurred) called for money targets. Not just any money targets, though, but those which:
“Pursuant to this resolution, and taking into account the international flows of funds and conditions in the international money and credit markets, the Board of Governors shall consult with Congress at semi-annual hearings before the Committee on Banking, Housing and Urban Affairs of the Senate and the Committee on Banking, Currency and Housing of the House of Representatives about the Board of Governors' and the Federal Open Market Committee's objectives and plans with respect to the ranges of growth or diminution of monetary and credit aggregates in the upcoming twelve months.” [emphasis added]
Congress didn’t mandate the Fed to meet any such constructed monetary targets, just that the central bankers might consider it a start in preparing them. A gauntlet thrown down to test the central bank monetary mettle.
Beginning in 1975, that’s what Arthur Burns’ Fed did. They began crafting and publishing targets for M1 – even though months before the FOMC had held several discussions about how pointless this would be given how M1 and M2 had been rendered obsolete years if not more than a decade before.
William Abbott of the St. Louis branch had set out all the way back in 1960 to revamp the monetary definitions and statistics because even at that early time there was an obvious need. By 1971, he’d come up with alternatives M1 through M5 – which were promptly ignored.
J. Alfred Broaddus and Marvin Goodfriend wrote a paper in 1985 which basically spelled out the charade. They called their article Base Drift and the Longer Run Growth of M1: Experience From A Decade of Monetary Targeting.
To sum it up: the Fed’s M1 targets consisted of a range starting in 1975 for what M1 should be four quarters out. And when the M1 growth rate in practice actually exceeded that prior target, the Fed would simply apply the next target for four quarters out to the result which had been excessive, not considering the prior starting point four quarters earlier.
Broaddus and Goodfriend calculated that had the Fed been effective at limiting monetary growth right from the get-go, 1975, and kept it within its original target path, by the end of 1984 M1 would’ve been $177.2 billion. It actually was $534.5 billion.
But the authors admit their great difficulty in attempting to figure out what they believed would have been the correct path, or what M1 “should” have been. “First, M1 was redefined at the beginning of 1980. Second…the reported growth of M1 was distorted by the legalization and rapid growth of negotiable order of withdrawal (NOW) accounts and other interest-bearing transactions accounts in several years during the period.”
Short version: figuring out money supply isn’t so easy, and what to do with it even more complicated.
And that’s exactly why the Fed stopped doing anything with money. While Broaddus and Goodfriend were writing about the problem with target base drift, Congress’ delegated monetary authority got out of the money business altogether substituting it with interest rate targeting. Targeting not with money, but with words (moral suasion).
By June of 2003, however, things had come full circle – almost. For reasons they couldn’t exactly figure out (but Ross Perot did), the recovery from the unusually mild dot-com recession just wouldn’t ignite. A year and a half after it had ended, Alan Greenspan’s gang of policymakers sat around the FOMC conference room table and began to seriously consider the impossible.
While ostensibly they were there to vote the fed funds target down to a record low 1% level, doing so put them in range of Japan. The zero lower bound (ZLB), which the Bank of Japan had reached back in ’99, was suddenly a realistic possibility for US central bankers, too.
This fact triggered a wave of discussions on both the Japanese experience with the ZLB to that point as well as some thinking ahead about nominally what this would mean for technical matters here in America. After all, once you get down to zero what’s left at that point is, essentially, money supply targeting.
They can call it quantitative easing all they want, but on a nuts and bolts level that’s really what’s going on. The central bank is attempting to manipulate the presumed money supply in order to circumvent the natural limitations exhibited in a world where interest rates are not naturally negative.
Not just present but prominent in these talks was the then-President of the Federal Reserve Bank of Richmond, one Al Broaddus.
He like many others voiced several key doubts about going back to money targeting, and why wouldn’t he? His earlier experience had shown, proved to many, the idea was fraught with enormous challenges. The very kinds of hurdles the Fed in the eighties had simply set aside; they never solved these monetary definition and measurement issues, they had just convinced themselves and everyone else these would never matter in this brave new future.
But here they were, like Japan, considering a future where the Fed might have to wade in on the monetary side of things all over again. Broaddus was more than a little wary:
“MR. BROADDUS. So the next step is that we use what are being referred to as quantitative policies in this discussion. In principle, I think it can’t be denied that they would work. In practice, though, there are a lot of obstacles to creating credibility for these kinds of policies.”
To which Board Governor Ed Gramlich added:
“MR. GRAMLICH. If we started doing more quantitative targeting, how would we do it? That is, do we want 5, 6, or 7 percent money growth, and over what time period do we want that growth—for three months or six months? There are a lot of issues involved, and I don’t know how to sort through them.”
And when they all talked about “money” in thinking through going back to a quantitative regime, what they meant was bank reserves. Why? Because that’s all the Fed had in its arsenal, and all it has today. Take away the fancy sounding names and the often-complex targets of today’s Fed, where the monetary rubber hits the financial road in the central bank context it does so only in the form of bank reserves.
But these guys were not monetary students any longer, so the entire discussion took on its more common modern format especially in the FOMC’s lengthy critique of the Japanese experience with QE – which, to put it bluntly, was not very good.
What the Japanese had done wrong, in the minds of US policymakers in June 2003, was that they hadn’t sold the program the right way or with enough conviction. Not that they had used inert bank reserves because they couldn’t define money or what forms the banking system used in practice, but, expectations policy, Japanese officials didn’t openly display enough confidence so as to build up credibility about the “money” they were “injecting.”
If you need to sell money, it’s not.
“MR. KOHN. We don’t need to be very specific; but before we begin to use nontraditional techniques, I think we need to talk about them publicly and create a sense of continuity and confidence in our policymaking, which I believe was absent in Japan.”
If money is money, there’s no need to make the public confident about it. It just is. And banks know it is, so they do something with it. But that’s not what happened in Japan, as Don Kohn next pointed out:
“MR. KOHN. Finally, I have some doubts about the efficacy of quantitative easing. I know there’s a long-run relationship, and somehow one would think that the central bank ought to be able to set the price level by printing an appropriate amount of money. But as Al Broaddus said, the problem is that the relationship between prices and money growth might be a very weak one. It might not hold over short or even intermediate periods of time. I wouldn’t reject quantitative easing as a possibility if we got to that point, but it’s down on my list, and I would be careful about conveying a more confident attitude about the efficacy of that technique than I think we feel.”
We don’t do money, so we better be careful about making extravagant claims if we are forced onto the money side of policy ever again! Unbeknownst to them at the time, though it should’ve become knownst had they kept up with monetary competency, that day was just five years into the future.
For most of the public, these kinds of discussions probably seem alien, particularly over the last several months when the Fed has made a concerted effort to get the public to think monetarily of its bank reserves. Scarcely a day goes by without some major financial media outlet publishing a story about the massive level of money printing and how it is sure to be inflationary very soon.
Not even the Fed actually believes this, since deep down they know for a fact that they don’t know much about money.
That’s why the need, in their view, for the sales job; the Japanese didn’t need to be better in money, they reasoned (irrationally), the Bank of Japan needed to be a whole lot better at selling the Japanese public on bank reserves as money.
June 2003’s discussions sort of hit home in May 2020, with the media currently relaying every move of Jay Powell’s full court press as the most impressive thing ever done in any financial context – which is actually the whole point. Powell’s a marketing guy now. Central bankers used to be bankers but then came the Economists who transformed the job into a used car salesman (apologies to them for associating the reputable retail auto business with this mess).
And now they are simply clowns conducting what amounts to the most pitiful, and ultimately costly, form of performance art. Just as the Japanese have been.
Article 1, Section 8 of the Constitution empowers Congress alone to coin money, which Congress then delegated to the Federal Reserve. This circus is legal.