Brad Setser

Brad Setser: Follow the Money

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Pot calling kettle black?

by Brad Setser
July 29, 2009

One thing that has puzzled me is that some of the countries that have — implicitly at least — been most critical of the expansion of the Fed’s balance sheet during the crisis long have had much larger balance sheets than the US Federal Reserve.

Before the crisis, the Fed’s balance sheet was around 6% of US GDP. Right now, it is around 15% of US GDP. A big increase no doubt. But the balance sheet of the People’s Bank of China (PBoC) is around 70% of China’s GDP. Foreign assets make up about 80% of the PBoC’s balance sheet — or around 55% of China’s GDP. And the PBoC’s estimated holdings of US treasuries and agencies are about equal to 30% of China’s GDP — a level that is far higher, relative to China’s GDP, than the US Fed is ever likely to achieve. The Fed expects its balance sheet to peak at roughly $2.5 trillion, or between 15% and 20% of US GDP.

pboc-v-fed-11

China consequently presumably knows a thing or two about how to prevent rapid expansion of the central banks balance sheet — including rapid expansion from purchases of long-term US Treasuries and Agencies — from producing unwanted inflation.

The key, of course, is to sterilize the expansion of the central bank’s balance sheet. That means to offset the increase in the banks’ financial assets with an increase in the central banks’ financial liabilities, rather than increase in base money.*

Paul Swartz and Peter Tillman — my colleagues at the Council’s Center for Geoeconomic Studies — have plotted the growth in the balance sheet of the PBoC (relative to China’s GDP) and the growth in the Fed’s balance sheet (relative to US GDP). By China’s recent standards, the expansion of the Fed’s balance sheet isn’t particularly unusual.

Indeed, there have been several years when the increase in the PBoC’s balance sheet due to its Treasury and Agency purchases looks a bit like the current increase in the Fed’s balance sheet from its Treasury and Agency purchases — at the following Paul Swartz graph, which draws on the Setser/ Pandey data on China’s US holdings — shows.

pboc-v-fed-2

One note on the graph. The dip in the Fed’s holdings in 2008 reflected the sale of Treasuries to “sterilize” the Fed’s lending to the financial sector following Bear Stearns’ near collapse.

On a more serious note — a lot of emerging market economies have long had central banks with large balance sheets, whether because of extensive lending to their domestic banking systems or a high level of international reserves. Managing a large balance sheet is of course a challenge. But it isn’t something that is totally unprecedented. And I suspect that the Fed is spending a lot of time thinking about how it could go about sterilizing its now much expanded balance sheet should that prove necessary.

Take a look, for example, at Bill Dudley’s latest speech. (h/t Calculated Risk)

He writes:


“The addition of interest on reserves to the Fed’s toolkit effectively broke the link between the size of the Fed’s balance sheet and the stance of monetary policy. Policymakers now had the capacity to expand the size of the Fed’s liquidity facilities and other programs without the threat of compromising the control of monetary policy. …. In addition to paying interest on excess reserves, the Federal Reserve also has the ability to drain the excess reserves from the banking system. This can be done in a variety of ways: reverse repo transactions with dealers and other counterparties, securities sales from the Fed’s portfolio or bill issuance by the Treasury, with the funds deposited at the Federal Reserve. …. In other words, contrary to what is sometimes argued, it is not the case that our expanded balance sheet will inevitably prove inflationary.”

Many emerging market central banks can testify that this is indeed the case.

* Or to be precise, a bigger increase in base money than the central bank desires to achieve its monetary policy goals.

41 Comments

  • Posted by HZ

    Chinese banking system leverage is much smaller so is velocity of money — it is still largely a cash economy.

  • Posted by HZ

    The composition of asset and liability matter too. Chinese central bank holds external claims on the asset side and RMB on the liability side. So it is the Chinese taxpayers who should be concerned about its balance sheet since they will be expected to shoulder the loss — either that or inflation, but there is not that much RMB circulating outside of China. The Fed, on the other hand, used to have half of the notes circulating outside of the US. There are a tremendous amount of USD assets held overseas. So it is not hypocrisy for the PBoC to be concerned about the Fed balance sheet. OTOH, the Fed has little real interest in PBoC’s balance sheet.

  • Posted by Twofish

    Also, I don’t recall China being particularly critical of Fed policy. The only thing coming publicly out of China is a mild “it would be a good thing if we got some of our money back.”

    But China has hardly been critical of the anything that has happened post-crisis.

  • Posted by bsetser

    China seems worried that the balance sheet expansion of the US — i.e. the expansion of the asset side, and resulting (potential) increase in base money — will be inflationary. I don’t think the domestic/ foreign mix of the assets is relevant to that concern. the issue is whether or not the increase in the central banks assets can be sterilized

    the obvious difference is that a country building up foreign assets is intervening to limit nominal currency appreciation, while a country that is buying domestic assets b/c policy rates are at zero and it wants an even easier monetary policy typically isn’t fighting underlying pressure for appreciation. So the risk of $ depreciation differs from the risk of RMB depreciation. But if china was worried about dollar depreciation, it really never should have bought so many dollars in an effect to keep teh rmb from appreciating and the dollar from depreciating …

  • Posted by Twofish

    The problem with isn’t with the current size of the Fed’s balance sheet which I think is more or less irrelevant. The two issues that are coming up are:

    1) the size of the fiscal deficit in the coming years

    2) the role of the Fed. The problem with the Fed’s balance sheet isn’t it’s size so much as the Fed for a moment in time was basically the only funder of mortgages and bank credit and for a few months, people got their credit cards and mortgage loans pretty directly from the Fed.

    The question that people are asking now is what should the Fed do. Should the Fed be *both* the lender of last resort and the main financial regulator for the financial system? Also, what is going to happen with all of those mortgages that the Fed has on its balance sheet. What is the role of Freddy and Fannie?

  • Posted by HZ

    Brad,
    Yes that is the key. The complaint you see from the Chinese side is that the Fed (as far as they are concerned) sets monetary policy for a lot more of the world than just the US yet its concern is mainly domestic. So they want to have more “constraint” on the Fed. But of course the Fed thinks it is legally bound to consider the domestic condition despite large overseas holdings of both USD currency and USD assets (that is the US would like the privileges of reserve issuer, if any, but none of the obligations).
    I think that is the conflict.

  • Posted by Twofish

    bsetser: China seems worried that the balance sheet expansion of the US — i.e. the expansion of the asset side, and resulting (potential) increase in base money — will be inflationary.

    There are certainly Chinese economists that worry about this, going from “some Chinese economists worry” to “China worries” is like trying saying that “The US worries” based on what Paul Krugman says.

    My sense is that the Chinese government is worried about anything that would cause inflation, but I’ve seen nothing to indicate that people in policy making roles have any particular concerns about the sign of the Fed’s balance sheet.

    bsetser: But if china was worried about dollar depreciation, it really never should have bought so many dollars in an effect to keep the rmb from appreciating and the dollar from depreciating …

    I think the worry that a lot of people have at this point is a repeat of the 1970′s when inflation went in the 20% mode, but if that happens then the currency losses would be more or less irrelevant compared to the other impact you have on the global economy.

    One other thing, a dollar depreciation is just not going directly to cause the Communist Party to fall. If the PBC takes massive losses on its currency reserves, it’s hard to get from that point to riots in the streets. If you have an Indonesian style currency crisis, then it’s pretty easy to get from that point to something that would overthrow the Communist Party.

    So this is going to bias what the Party is worried about.

  • Posted by HZ

    Twofish,
    If Fed holds the line and refuses to monetize the fiscal deficit then the fiscal deficit will not necessarily bring inflation — it will instead crowd out private investment.
    However with huge structural deficit on the horizon I think people are right to be suspicious of the Fed’s determination (or even its independence will survive).

  • Posted by Twofish

    Can we mention some names? The Chinese economists that I hear quoted in US newspapers a lot aren’t particularly central in Chinese policy making, and I think that they get quoted a lot in the Western press because of unease within the US over fiscal deficits.

    One other thing about newspaper bias. Newspapers like conflict, and if a Chinese economist said “I think the Fed is doing the right thing and I don’t worry about very much” then they are never going to be quoted in Bloomberg.

  • Posted by Twofish

    HZ: However with huge structural deficit on the horizon I think people are right to be suspicious of the Fed’s determination (or even its independence will survive).

    I’m not sure that talking about the Fed as an independent agency makes any sense. The model of the Fed being this aloof agency that sets policies without caring about political pressures is totally dead. Now that the Fed has things other than treasuries in it’s balance sheet it is simply impossible for the Fed to be an apolitical, independent agency.

  • Posted by Twofish

    Also one reason why China has been pretty non-critical about US policy is that Chinese and US reactions to the crisis have been more or less identical.

  • Posted by Bob_in_MA

    Brad,

    A while ago, you estimated that China was sterilizing about 65-75% (if I remember correctly) of the expansion of their dollar holdings through debt sales.

    Do you have any idea what’s happening now? If they wanted a quick and dirty way to push expansion, might they not suspend the sterilization sales?

    Thanks,
    Bob

  • Posted by bsetser

    2fish: google china inflate its way out … see what comes up (hint, it isn’t concern about Chinese inflation). i have been at a couple of conferences where chinese gov officials have more or less taken it for granted that the US plans to inflate its debt away, and thus erode the dollar’s value. i accept the USD is likely to fall v the RMB, but i thought that back in 03/04, well before the the fed started its balance sheet expansion.

  • Posted by Cedric Regula

    HZ:”But of course the Fed thinks it is legally bound to consider the domestic condition despite large overseas holdings of both USD currency and USD assets (that is the US would like the privileges of reserve issuer, if any, but none of the obligations).
    I think that is the conflict.”

    The Fed has never been able to pull that one off, because it is impossible. That is the basic flaw in the current global reserve currency system. That’s also why everyone gets mad at us over “dollar hegemony”. Whenever the Fed implements domestic policy as they see fit, it causes a major hiccup elsewhere in the world.

  • Posted by HZ

    Brad,
    yes Chinese inflation is more a risk than US inflation (resulting in a real appreciation of the exchange rate) but since few outside of China hold RMB denominated assets it is really not a direct concern to most outside of China; hence you hear more concerns about Fed balance sheet than PBoC balance sheet.

  • Posted by don

    I think the fundamental inflation worry is whether the U.S. government will set a credible budget to eventually repay its debt. I doubt they will.
    The Fed has all kinds of tools to prevent inflation. Since it can pay interest on bank deposits, it needn’t remove all the excess reserves in order to prevent inflation. It is a red herring to worry about the Fed’s balance sheet as far as the effect on its ability to prevent inflation. More relevant is the indirect effect of this balance sheet – namely, if it accrues bad assets that impose losses on taxpayers. That is, the Fed and Treasury may wind up incurring greater debt on behalf of taxpayers than taxpayers will be willing to repay.

  • Posted by Cedric Regula

    Firstly, EMs in general have a rather spotty history of maintaining their external currency valuations and controlling internal inflation. So this makes me suspicious of CB magic tricks.

    But I have been paying attention about how the Fed says they intend to transform themselves back from a temporary hiatus as the world’s largest pawn shop, into a humble FOMC trading desk.

    They have expanded base money from $800B to $1.8T in one year. It took since 1913 to get to $800B, for reference.

    Brad quoted the ways I’ve been hearing:

    “In addition to paying interest on excess reserves, the Federal Reserve also has the ability to drain the excess reserves from the banking system. This can be done in a variety of ways: reverse repo transactions with dealers and other counterparties, securities sales from the Fed’s portfolio or bill issuance by the Treasury, with the funds deposited at the Federal Reserve.”

    The Fed recently said they are not going to dump the longer term “assets” on the market, because that would scare the crap out of the market. So these assets cannot be used to soak up liquidity.

    That leaves sterilization bonds, which I heard need Congressional approval, tho I don’t know of any reason the Fed wouldn’t get it.

    Or Ben’s favorite one seems to be paying high enough interest on bank excess reserves at the Fed to control velocity and the money multiplier if those things ever start acting like they used to.

    Just that the money for interest needs to come from somewhere, so this all sounds sort of weird and different. So I don’t know what to expect.

  • Posted by Michael

    Your analysis is good as always, Brad, but your lead-in premise is (artificially, I assume) naive.

    No one else would care if the U.S. had central bank balance sheets of 200% of GDP if its economy and its political, military, and financial influence were on the scale of Paraguay’s. The rediculously obvious reality is that with the biggest economy, the most powerful – and most aggressive – military, the sole power to print the world’s currency, and the world’s center of banking, finance, and credit, EVERYTHING and ANYTHING that happens in U.S. finance – ESPECIALLY anything the agency that prints that world currency – is of life and death importance to the rest of the world. The current “crisis”/”recession”/”deflation” – the worst since WWII started in the U.S. with the arguable assistance of the Fed. The whole BWII universe is dependent on the Fed being THE MOST STABLE AND RESPONSIBLE central bank, and any evidence to the contrary is a world-wide disaster. I know you already know all this, but your premise seems to minimize, if not ignore it entirely.

  • Posted by Twofish

    bsetser: 2fish: google china inflate its way out … see what comes up (hint, it isn’t concern about Chinese inflation).

    I’m not getting any names of people that I think really matter.

    bsetser: i have been at a couple of conferences where chinese gov officials have more or less taken it for granted that the US plans to inflate its debt away, and thus erode the dollar’s value.

    And I’ve gotten the same sense, but “taking it for granted” is hardly the same thing as criticizing the Fed’s balance sheet expansion. Also, it’s not too hard to inflate the debt away. If China keeps rolling over short term debt at zero percent interest, then an inflation rate of 8% is going to get rid of much of the debt in a decade.

    One thing about being an outsider is that you can think thoughts that an insider can’t think. “We think you are going to inflate the currency in the end.” is something that a Chinese economist or government official can say or think. A US government official can’t say or think that, even though it may bewhat’s going to end up happening.

    bsetser: i accept the USD is likely to fall v the RMB, but i thought that back in 03/04, well before the the fed started its balance sheet expansion.

    It’s amazing how much money has been lost betting against the dollar.

  • Posted by don

    CR: “Just that the money for interest needs to come from somewhere, so this all sounds sort of weird and different. So I don’t know what to expect.”

    I wondered about this myself. The Fed gets interest on its holdings of Treasury securities and other assets (now mostly MBS’s), which sum to the reserves of the banks. It turns over the excess to the Treasury, after subtracting what it needs for operations. But is it possible they would need to pay higher interest to banks than what they collect? Could they run short of money and need to go to Congress for an appropriation? Or what if the MBS’s go sour and produce losses? What would happen to their independence?

  • Posted by Cedric Regula

    Don:

    I think all of those things are soooo possible.

    The obvious answer is for the Fed to print money to pay interest on bank reserves. But I don’t know if there are any legal constraints on that. Or they could have the Treasury sell bonds to pay bank interest. I think I’ll start writing up a bill to send my congressman which will outlaw that.

    They say they will hold MBS and whatever else they bought to maturity. So they would take the loss on non-performing loans, at a minimum.

  • Posted by bsetser

    2fish — it isn’t obvious that anyone lost money selling $ for RMB or EUR in 2003 and then holding them to now. That is a very different question than whether or not it makes sense to bet at against the USD at current prices.

  • Posted by Cedric Regula

    Brad:

    Me and Templeton Global Bond Fund made a bunch of money.

  • Posted by Twofish

    don: But is it possible they would need to pay higher interest to banks than what they collect?

    No since the Fed can legally order banks to deposit money with the Fed. A bank could theoretically opt out of the Federal Reserve system, but that would mean that it doesn’t have access to a printing press to print cash if there is a bank run.

    don: Could they run short of money and need to go to Congress for an appropriation?

    No need. The Fed has infinite capacity to print IOU’s (i.e. little green pieces of paper that are in your pocket). Congress (and everyone else) goes to the Fed for cash.

    don: Or what if the MBS’s go sour and produce losses?

    In that case they could increase reserve requirements and force banks to deposit money in the Fed or they could get Congress to issue Treasuries swap them for bad debt and then add the MBS losses to the national debt.

    It’s unlikely that the Fed is going to lose a huge amount with MBS’s, but this is very relavant for China which is going to have to cover the losses due to currency appreciation. Also having moving the bank losses to the national debt is basically want China did to clean up its banks.

    don: What would happen to their independence?

    What independence? The Fed lost whatever political independence it had over the last year. Why do you think that Bernanke is doing the talk show circuit and bashing bankers?

    I think at this point it’s best to regard the Fed as “non-partisan” rather than independent. The Fed is going to be an extremely political agency, but as long as it doesn’t favor the Democrats or the Republicans, there isn’t going to be a problem.

    Right not there isn’t a huge difference between the Democrats and the Republicans as far as monetary policy goes. That wasn’t always the case, and monetary policy was *the* hot political issue of the late 19th century.

    Also I should point out that for things like finance, health care, tort reform, the way that things get decided in the United States really isn’t that different from the way that things get decided in China. In these areas, the real decisions are made in long dry committee hearings which 99% of the people would fall asleep in. The people that care are a small subset of special interests and technical experts, each with political connections within the bureaucracy.

    There are some stunningly important decisions that are being made when to comes to the financial system right now. But now that it looks like the world is not about to end, the general public no longer cares, which means that policy is being made by the “usual suspects” of lobbyists, special interests, and bureaucrats.

  • Posted by Too Much Fed

    don said: “More relevant is the indirect effect of this balance sheet – namely, if it accrues bad assets that impose losses on taxpayers. That is, the Fed and Treasury may wind up incurring greater debt on behalf of taxpayers than taxpayers will be willing to repay.”

    Bingo! Time to put some people in Congress that will NOT bail out the fed. Let them go bankrupt!!!

  • Posted by Too Much Fed

    Twofish’s post: “don: What would happen to their independence?
    What independence? The Fed lost whatever political independence it had over the last year. Why do you think that Bernanke is doing the talk show circuit and bashing bankers?”

    If bernanke wants to bash bankers then do NOT bail them out! IMO, bernanke’s talk is a half-truth at best.

    Anybody ever consider that bernanke is considered an “expert” on the Great Depression because his “solution” is to bail out the banks at taxpayer expense? Is that the reason he was appointed to the fed in the first place?

  • Posted by Armando

    Here is a link of John Ross in which he pretty much demolish Petty on so many points that Michael Pettis simply could not argue against John Ross other than dismissing JR argument.

    Michael Pettis and Brad Setser like to quote each other and both share similar view so John Ross is a good counter argument to both view.
    Here is link of John Ross
    http://ablog.typepad.com/keytrendsinglobalisation/

  • Posted by Indian Investor

    PBoC has US Treasury junk bonds and the Fed has junk corporate bonds.

  • Posted by Rien Huizer

    Twofish

    ” The question that people are asking now is what should the Fed do. Should the Fed be *both* the lender of last resort and the main financial regulator for the financial system? Also, what is going to happen with all of those mortgages that the Fed has on its balance sheet. What is the role of Freddy and Fannie?”

    And that is a very good question! One of the legacies of the previous US gvt’s shortsighted push for expansion of executive discretion.

    Now there is some solace. Whatever changes in US regulations tends to be for the worse, and probably the financial system reform will be incomplete and ultimately driven by interest groups. So I would not worry too much about the regulatory task getting in the way of monetary policy. The powers that an ideal financial US regulator would need are simply beyond the capacity of the US political system to produce.

    A bigger worry is that the Fed has never been sufficiently independent, and I guss that is the main worry. You have the strange paradox than no country has as many distinguished academics that could design, build and operate a very sound and still low-friction financial system but it would be against the private interests of too many relevant people. That is the main reason why I doubt that the US (i e the potentially constructive executive plus the unreformed and hungry congress) will take the high road of financial discipline. It would be totally irrational.

    So inflation we will get if, big if, the economy can be made to move in the growth direction. Most likely the Chjinese have come to the same conclusion but what can they do if the US executive itself faces political constraints.

  • Posted by bsetser

    Armando — I don’t think I questioned the effectiveness of stimulus, though for a while I was worried that China’s fiscal stimulus might be too modest. The scale of the expansion of bank lending (an off budget quaisi-fiscal stimulus given that such loan growth has put that concern to rest). I don’t doubt that China is growing now on the back of the stimulus, and I agree that in q2 there is evidence that the stimulus is bring China’s external surplus down.

    in a lot of ways, my views on China’s stimulus are closer to Qing Wang’s views than Michael Pettis’ views. See:

    http://www.morganstanley.com/views/gef/archive/2009/20090729-Wed.html#anchor94a2f39f-7c3d-11de-b5d1-6d6288639586

    Nothing seems to get attention like a provocative title incidentally. My main point though is that large central bank balance sheets are actually the norm in the emerging world, and don’t always produce inflation. The mistake Nouriel and I made back in 2004 was underestimating China’s ability to sterilize the growth in the pboc’s balance sheet associated with the stupendous increase in its reserves.

  • Posted by Brick

    The Fed thinks it can drain reserves by reverse repo transactions with dealers and other counterparties, securities sales from the Fed’s portfolio or bill issuance by the Treasury, with the funds deposited at the Federal Reserve.
    I can think of reasons why all 3 would hit problems. Dealers don’t have to enter into repo transactions, securities may not be all that saleable and bill issuance might have undesirable side effects. Not that it makes much difference, nor that the balance sheet is most probably over valued. Possible monetisation of treasury issuance with QE or currency dislocation would seem to me to pose a much greater risk of stoking longer term inflation.

  • Posted by Twofish

    Huizer: I would not worry too much about the regulatory task getting in the way of monetary policy. The powers that an ideal financial US regulator would need are simply beyond the capacity of the US political system to produce.

    But what about the monetary policy task getting in the way of the regulatory task? Because the Fed was trying to stimulate the economy, it wasn’t paying too much attention to cracking down on bad loans. This is why China split out the CBRC from the PBC. It’s also why the US should consider it.

    This crisis is over. I’m worried now about the next one. There *will* be another financial crisis in a few years. The question is will it be something that’s over in a month, or will it threaten to or actually bring down the world financial system.

    Also, I don’t care about creating an ideal regulatory system, I just want one that isn’t totally incompetent, and which doesn’t allow the world to come within one decision of total financial collapse. The theory of the past two decades was that governments were bad, so if you could have governmental paralysis, this was a good thing since it lets markets develop without interference.

    I don’t think that works.

    Huizer: You have the strange paradox than no country has as many distinguished academics that could design, build and operate a very sound and still low-friction financial system but it would be against the private interests of too many relevant people.

    I do not think an economic system can be designed, and people that have designed economic systems have tended to create disasters. Economic systems evolve.

    One huge problem in political systems design is that academics see themselves as “impartial” and “rational” when in fact academics are just another interest group that wants money and power, just like everyone else. Also people in academia, vastly underestimate how difficult political problems are.

    Academics are extremely dangerous when you put them in political positions, since non-academics often know when they are being idiots and stop, whereas academics think that they are smarter than everyone else, when they often aren’t. It’s not a consequence that probably one of the worst economic disasters in 20th century history (Khmer Rouge) was run by academics. It actually comes out of the academic view. Since politics makes doing things difficult, the logical thing to do is to end politics, but that takes to lead to total social disasters. Instead of going through decades of committee meetings, get enough military or economic power to say “Do things this way!!!” It’s usually not ended well.

    Huizer: So inflation we will get if, big if, the economy can be made to move in the growth direction.

    One important fact is that the amount of inflation that you need to reduce the amount of Chinese debt holdings is not huge. Five percent inflation over a decade is going to reduce your holdings something like 60%. When Chinese economists worry that inflation is going to reduce the value of their holdings, I don’t think that anyone is thinking about Zimbabwe, just having inflation go up to 5%-8%.

    There are things that China could do to reduce losses. However, how to reduce losses or whether to even try is a complex question.

    Also there may be a political consensus in the US to do just that. If people have large amounts of debt, then inflation starts looking good politically.

  • Posted by Twofish

    One other thing that the central bank can do which commercial banks can’t (at least not sustainably) is to fudge the value of their balance sheets. Basically the mortgage backed securities that the Fed owns are worth whatever the Fed says they are worth. Commercial banks can’t do this sustainable. It’s not a matter of accounting rules, but rather market dynamics.

    If a bank says that the brick of lead in the vault is worth a billion dollars, then depositors get scared, they go to the bank and want their cash money. If you can’t turn that brick of lead into a billion in cash money, then you get even more depositors wanting their money.

    The Fed doesn’t have to worry about that. If someone shows up and the Fed demanding cash money, then the Fed just prints a few extra dollars. If the Fed goes Zimbabwe and prints too much money, then you have inflation, but it’s a not a bank run.

    Also this means that transferring Chinese currency risk from commercial banks to central banks is not a irrelevant thing. Yes the total risk may be the same, but what matters is who holds the risk. It’s like transferring money from one account to another. If you just care about totals, then taking all my money and moving it to your account means nothing, but to me (and you) it means a great deal.

    There are items on the Federal Reserve balance sheet that arebasically “we just printed some money” entries. Credit extended to AIG and Term Asset-Backed Securities Loan Facility, for example.

  • Posted by Cedric Regula

    As the CFR commentator on space alien relations. I do have some experience to relate on how monetary policy evolved on Vorlon.

    Vorlon is similar to China in many ways. I have read here that China has at least 50 races and is therefore a very diverse society. In the case of Vorlon, there are exactly 57 races, and there is also a law that states no one is allowed to try and change that. That is an article in the Vorlon One World Government Constitution, and was a key element in getting the One World Government (OWG) elected to power.

    I know it’s quite surprising to Earthlings that a world government could get elected to power, but all races on Vorlon seem to believe that war is dangerous and bad for your health, so they have always sought political rather than military solutions to conflict. As a result, there has never been a war on Vorlon, at least in recorded history.

    So that’s some background info, and now on to how monetary policy evolved on Vorlon. Back when they had the election to elect the OWG to power, the OWG had crafted an entire Constitution as their running platform. Then they published it in book format and gave it away for free at supermarkets. This was done for the obvious reason that the Vorloni public wished to know what they are voting for. On voting day all Vorloni were instructed to wave an appendage of their choice indicating a yes vote, and public surveillance cameras would be used to estimate the vote. After much appendage waving, the OMG was officially voted into power and the new Constitution was ratified at exactly the same moment.

    But the night before, some unknown member of the ruling council slipped an earmark into the Vorlon Constitution. It became known as the One Economist Article, and states that, legally, there can be only one economist on Vorlon and all other economists must go find a job.

    In order to comply with the article, the OWG held a lottery to select the official economist. An economist by the name of Dr. Crugman won the lottery.

    Dr. Crugman is a member of the Conscience race on Vorlon and their physiology is rather unique and is relevant to the understanding of this species. The Conscience exist as a “collective” of between 6 and 12 individual minds, all linked together at the hip, and share between 18 to 36 appendages that they use to motivate themselves and manipulate their surroundings. Having 6 to 12 minds makes them excellent at math, especially once they get the hang of multitasking. This skill is what naturally made Dr. Crugman interested in the science of economics. Also, the Conscience are gatherers (hunting is illegal on Vorlon, but all fruit trees are in the public domain) and each collective eats by stacking itself next to a fruit tree, with the topmost member picking the fruit and “handing” the fruit down to the next member below. This continues until the bottom most member eats the fruit and it is subsequently digested and passed thru the common circulatory system. So it’s easy to see that the attitudes and political ideologies of the Conscience are quite socialist and liberal. No one has ever seen the Conscience procreate, but rumor has it that this is quite interesting as well, and the party game, Twister, sells very well in the Conscience community.

    Upon being appointed as the official One Economist, Dr. Crugman was assigned to work on Vorlon’s most serious economic problem, the gold standard. Gold is not indigenous to Vorlon, and the lack of adequate supply regularly causes the Vorlon economy to go into depression. Vorlon has always had a thriving casino industry, in the hopes of attracting interstellar tourism and the hard currency they spend, but even so the gold supply did not seem to grow fast enough to support the Vorlon economy. A populist movement for silver coinage sprang up, but critics pointed out that Vorlon has no indigenous silver either, so that idea fell by the wayside.

    Employing his considerable math skills in calculus, partial derivatives (note to earth readers: these are not the same thing as naked derivatives) and a Fourier transform here and there, Dr Crugman modeled the Vorlon economy and bench tested some ideas he was working on. He concluded that the optimum result could be achieved if a new medium for money was constructed that could be made plentiful enough to support economic growth, but at the same time would somehow be of value to the citizens of Vorlon. This way they would willingly use it for economic exchange and move off the gold standard. After much research at the Vorlon Public Library, and studying an ancient, obscure Vorlon economist by the name of Ceynes, Dr Crugman concluded that this could be accomplished if money could be made to multiply both by central government control and also each individual piece of money would multiply, giving the individual a sense that this new money had value.

    So he consulted with Vorlon’s foremost zoologists and marine biologists for a suitable instrument. Some necessary attributes to qualify as candidates for money are; small enough to carry around, government control over the source, and also some attribute that would make the holder of the money be conflicted over whether to spend it or horde it. This was found to be necessary in model simulations, because velocity of money was proven to be vital to the economy’s health. As a corollary, money should not be edible, as this could lead to a serious drop in the money supply.

    After studying hundreds of candidates, the Vorlon Sand Dollar was selected. This met the requirements for money quite well, and then some.

    1) They are about the size of a quarter.

    2)The OWG could planetize Vorlon’s oceans, and create a new entity for management of the monetary resource, the Federal Preserve. In order to pay for the new administrative cost and improve efficiency in government, the Unemployment Office would be merged with the Federal Preserve. The unemployed would be directed to migrate to the beach and assist the government in collecting money, for a five percent commission.

    3)Sand Dollars smell bad and taste bad, ensuring that the consumer will have some motivation to spend them rather than horde them, and reduce the possibility of the economy getting stuck in a liquidity trap.

    4)When you rub two Sand Dollars together, they each split into two more Sand Dollars in exactly 254 days. This happens to be equal to one solar rotation on Vorlon, and Dr. Crugman was nearly giddy over the mathematical elegance in determining the per anum rate of return on Sand Dollars…100% per annum. That should sound good to any fool on Vorlon. Dr. Crugman was convinced the gold standard would be abandoned.

    The OWG quickly implemented the new monetary system and Vorlon lived happily ever after.

    So that’s how it works on Vorlon. Now we will have to see what Earthlings come up with.

  • Posted by jonathan

    Thanks. This was illuminating.

  • Posted by Michael

    Brick,

    Bernanke’s official position on how he’s going to “drain reserves” when the time is right – to prevent undesirable inflation (obviously he is in favor of some inflation at the current time) – is to raise the interest rate the Fed is paying on bank reserves – essentially freezing them in place (and encouraging their increase) so they are removed from business and commerce (note that “draining the reserves” in this model doesn’t actually mean decreasing them, just keeping them away from everyone but the Fed).
    I get the impression that Professor Bernanke is still really attached to his academic theories about monetary policy even when they have not worked, are not working, and make no sense in the real world (the Friedman Effect).

  • Posted by bsetser

    michael — there is actually plenty of real world experience with sterilization; china is a case of successful sterilization. the problem is that this experience is more common in the world’s emerging economies than in the us.

  • Posted by Pax Americana

    America needs a Fed/Res that is “independent” of any and all political interference, from politicians.The Fed has enough problems with domestic policy, let alone factoring in external ramifications for other Nations of our Polity. Also agree with the above statment on US educational average attainment, which is wholly inadequate for the modern world, America now inhabits.

  • Posted by RebelEconomist

    It occurs to me that the pot-calling-kettle-black argument also applies to the US urging China to allow the value of its currency to be determined by the private sector in a free market while intervening itself to resist market-determined US mortgage rates.

  • Posted by Matt Call

    Thanx for your nice article. But I had difficult time navigating around your site because I kept getting 502 bad gateway error. Just thought to let you know.

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