The Central Banking Journal annually awards central bankers (best governor, best central bank, and providers of services to central banks) for their performance. This year’s ceremony was held in London on March 13 and I was awarded Outstanding Contribution for Capacity Building. Here is a video of my acceptance speech.
The U.S. constitution gives Congress the authority to enact and control tariffs (taxes on American consumers of imported goods and services). Over the years Congress has increasingly delegated that authority to the executive branch (the President) under certain specified circumstances. Section 232 of the Trade Expansion Act of 1962 gives the President the authority to restrict (impose tariffs on) imports that threaten national security without the need for congressional approval.
Last year President Trump imposed a 25 percent tariff on steel imports and a 10 percent tariff on aluminum on the grounds, confirmed upon the President’s prompting by the Commerce Department, that relying on steel from Canada and the EU (fellow NATO members) was a threat to our national security. If this were a skit on “Saturday Night Live” we would have a good laugh, but unfortunately it is for real. It is the launching of a very ill-advised trade war by a President who had promised when campaigning for office to reign in executive overreach. Sen. Ben Sasse, Republican from Nebraska, called Trump’s decision “dumb.”
Trump’s stated motive was to restore American jobs to an industry in which we are relatively inefficient. The few additional workers in steel and aluminum resulting from these tariffs were outweighed by the loss of jobs in industries dependent on these now more expensive metals as inputs. Bestowing financial favors on a selected group to the detriment of the rest of us can rightly be called corruption. https://wcoats.blog/2018/09/28/trade-protection-and-corruption/ Such policies do not reflect America First. They reflect My Friends First.
Trump has apparently asked the Commerce Department to “evaluate” whether importing cars is a national security threat that would allow him to impose tariffs on them without Congressional consent. So much for rolling back executive overreach and any consideration of the national interest.
Both Republicans and Democrats may have had enough of this. “While the Trump Administration ponders whether to claim that imported Volkswagens threaten national security, some on Capitol Hill are trying again to rein in the President’s tariff powers.” WSJ: “Two-bills-to-defend-free-trade”
Two bills have been introduced in the House that would shift the responsibility of determining if an import is a national security risk from the Commerce Department, which naturally leans toward protecting American commerce, to the Defense Department, which should better understand real security risks. “The stronger bill was introduced last week by Senator Pat Toomey, the Pennsylvania Republican…. Mr. Toomey’s bill would require Congress’s blessing. Once a tariff is proposed, lawmakers have 60 days to pass a privileged resolution—no Senate filibuster to block consideration—authorizing it. No approval, no tariff.” WSJ 2/9/2019 A somewhat weaker bill has been introduced by Senator Rob Portman, Republican from Ohio, on the grounds that it has a better chance of passing over a Presidential veto.
Please write your congressional representatives to support one of these bills (preferably the Toomey bill) before this President fights another war that we all lose.
Most Americans support legal immigration into the United States (preferably more and better targeted than now) and oppose illegal entry. Controversy has arisen over how best to limit the illegal sort (to say the least).
The border between the U.S. and Mexico runs almost 2 thousand miles. By 2009 580 miles of fence or wall had been built for the purpose of reducing illegal entry of people and drugs. This grew to 654 miles by 2017. Leaving aside the many controversies over the environmental impacts of fencing a border that runs through Indian reservations, and environmentally sensitive areas (“In April 2008, the Department of Homeland Security announced plans to waive more than 30 environmental and cultural laws to speed construction of the barrier.” Wikipedia), we must ask whether a fence/wall on even half of the border will significantly reduce, much less stop, illegal entry into the U.S. and whether it is the most cost-effective way of doing so (electronic “fences” are also now being deployed). The Economist magazine estimated that it may have “reduced the number of Mexican citizens living in America by only 0.6%.” “The-big-beautiful-border-wall-America-built-ten-years-ago” About half of all illegal emigrants arrived in the U.S. legally by boat or plane and overstayed their visas.
Where there is a will, there is a way. Illegal immigration is reduced when conditions (incomes and security) in a potential immigrant’s home country are improved, when legal channels of immigration widened, and when illegal entry and residence are made less attractive (riskier).
While the North American Free Trade Agreement (NAFTA), which came into effect in 1994, benefited the United States, it improved living standards in Mexico and Canada as well, President Trump’s condemnations notwithstanding. Over its first 20 years Mexican trade with the U.S. and Canada more than doubled. (Burfisher, Mary E; Robinson, Sherman; Thierfelder, Karen (2001-02-01). “The Impact of NAFTA on the United States”. Journal of Economic Perspectives. 15 (1):125 44. CiteSeerX 10.1.1.516.6543. doi:10.1257/jep.15.1.125. ISSN 0895-3309.) Per capita income (GPD) in Mexico increased 37% and in the U.S. 52% between 1993 and 2017.
An example of Trump’s misuse of data was provided by his statement during his recent State of the Union Address when he claimed that: “One in three women is sexually assaulted on the long journey north”, referring to the Mexican caravans to the U.S. border. The data comes from the Doctors Without Borders, who reported that of the 57 women caravaners who sought their medical care one third “said they were “sexually abused” on the journey, not “sexually assaulted” as Trump says.” This is not even in the same ball park. “Fact-checking-president-trumps-state-union-address”
On multiple occasions over the last 20 years sensible bipartisan immigration reform laws were proposed but never passed. We badly need to adopt some such reforms in order to meet the labor market needs of the U.S. economy and to settle the legal status of earlier illegal immigrants (including the Dreamers). See my earlier comments on such reforms: https://wcoats.blog/2017/02/12/illegal-aliens/ https://wcoats.blog/2018/01/11/our-dysfunctional-congress/
The most challenging component of the policies to reduce illegal immigration are policies to make illegal status as unattractive as possible. In short, a barrier to illegal status that immigrants can’t climb over, tunnel under, or walk around. Illegal status should be very unattractive. Illegal residence should not have access to any, other than emergency, welfare services. People generally immigrate to the U.S. in search of a better life. That generally means a better paying job than they could find at home. Employers who hire undocumented workers should be heavily fined (especially if the employer happens to be the President of the United States). Efforts to deny services and jobs to illegal immigrants should not intrude on the privacy and lives of legal residents however recently they might have arrived. Our conflicted approaches of overlooking illegal status, reflects our failure to have adopted sensible laws for legal immigration.
America is an attractive place to live and we have benefited greatly from the best and the brightest who have chosen to come here (legally). For our own sake and for the sake of those who might come we need to improve the process and widen the door for legal immigration while making the illegal sort less attractive.
As a monetary policy expert working at the IMF when the Soviet Union dissolved I had the exciting and fulfilling opportunity of leading technical assistance missions to the central banks of Bulgaria, Kazakhstan, Kyrgyzstan, Moldova and Slovakia and building on those experiences to a number of post conflict country central banks (Bosnia and Herzegovina, Croatia, Kosovo, Serbia, Afghanistan, Iraq, and South Sudan). I am grateful to the IMF and the wonderful colleagues I worked with for these opportunities and now I am grateful to the Central Banking Journal for acknowledging this work with its “Outstanding Contribution for Capacity Building Award.” I will received the award in London March 13. Award announcement
Starting with the repeal of the Corn Laws in England (tariffs on grain imports) in 1846, cross border trade and incomes blossomed. “Global life expectancy in the past 175 years has risen from a little under 30 years to over 70. The share of people living below the threshold of extreme poverty has fallen from about 80% to 8% . . . . Literacy rates are up more than fivefold, to over 80%. Civil rights and the rule of law are incomparably more robust than . . . only a few decades ago.” From The Economist’s 175 anniversary issue September 13, 2018: “A-manifesto-for-renewing-liberalism”
Post World War II trade agreements reflected a process of progressive reductions in tariffs and other impediments to trade. Unfortunately and misguidedly, President Trump has reversed this trend by introducing new tariffs and raising old ones. Import tariffs are taxes on American consumers. Why is Trump doing this? He says that he wants to bring manufacturing jobs that have moved off shore back to the U.S. by making their output cheaper than taxed imports.
As the U.S. economy is fully employed (there are currently more job openings than people looking for work), increasing employment in one area can only occur by reducing it in one or more other areas. Starting with Trump’s 25% and 10% tariffs on steel and aluminum, the shift from imported steel and aluminum to domestically produced steel and aluminum as a result of tariff protection is only possible by shifting workers from other more productive activities lowering the value of over all output. Given that these products are inputs into some American exports, which are thereby made more expensive, it is estimated that more jobs will be lost than created. “Econ-101-trade-in-very-simple-terms”
The U.S. has already imposed steep tariffs on China’s steel and aluminum to offset Chinese government subsidies to its steel and aluminum industries and thus we import almost no steel and aluminum from China. Trump has justified his new steel and aluminum tariffs on national security grounds thus bypassing usual World Trade Organization (WTO) rules for justifying tariffs. It stretches credibility, to say the least, to claim that depending on Canada and Mexico for steel is a security risk, not to mention that existing domestic production by itself exceeds our military needs. “Trump-says-steel-imports-are-a-threat-to-national-security-the-defense-industry-disagrees”
Some claim that Trump’s tariffs and threatened tariffs are just part of his negotiating strategy to achieve fairer trade agreements by a free traders at heart. This is belied by the fact that steel and aluminum tariffs remain on Mexico even after tentative agreement on a NAFTA replacement/update with Mexico. The question is why would someone benefit one small sector of the economy while imposing much larger harm on the economy more generally? The short answer is corruption.
Corruption in this context refers to bestowing benefits on a few at the expense of others in exchange for something else. In government, corruption generally takes the form of vote buying, though sometimes it is for personal financial gain. My bottom line here is that in addition to reducing an economy’s output and thus its resident’s incomes by protecting inefficient or less competitive industries, tariffs and other forms of economic protection reflect, or at the least open the door for and encourage, corruption.
When the government has or takes the authority to tax or exempt from tax individual industries or firms, it invites, if not begs for, corruption. Read the story of the Dixon Ticonderoga pencil company and weep. “How-dixon-ticonderoga-has-blurred-lines-of-where-its-pencils-are-made”
“Recep Tayyip Erdogan believes high interest rates are the cause of inflation, not the remedy for it” The Economist May 19, 2018 “How-turkey-fell-from-investment-darling-to-junk-rated-emerging-market”
During the 1990s the inflation rate in Turkey averaged around 80% per annum varying between 60% and 105%. Over that period interest rates on its 3-month treasury bills averaged about 30% above the inflation rate reaching almost 150% in 1996. The economy grew rapidly in real terms with real GDP growth averaging 8% per annum between 1995-7. But growth depended heavily on borrowing abroad in foreign currencies. Banks were poorly regulated, and heavily exposed to foreign exchange risk and to government debt. Obviously, Turkey’s nominal exchange rate depreciated at about the same rate as its inflation rate in order to preserve a stable real exchange rate.
In the wake of the Asian and Russian debt crises in 1997 and 1998 foreign investors became more risk averse and capital inflows into Turkey were reduced sharply slowing down economic growth from 7.5% in 1997 to 2.5% in 1998. A serious earthquake in Turkey’s industrial heartland in August 1999 further deteriorated Turkey’s economic performance. The combined impact of the two pushed the economy into a deep recession, shrinking GDP by 3.6% in 1999.
With support from the International Monetary Fund (IMF) in 1999-2003 the Turkish government reigned in its spending and monetary growth and reduced its inflation rate to 10% by 2004. I was a member of the IMF’s Turkey team at that time and remember the long sleepless nights very well. Turkey’s interest rates followed inflation down and, in fact, its real interest rates (nominal interest rate minus its inflation rate) fell from 30% to negative rates as the economy stabilized. During this transition, a number of state owned enterprises were privatized, 18 insolvent banks were intervened, and debt and the financial sector were restructured and strengthened. Within a few (rough) years the economy was growing rapidly with low inflation and low interest rates. In 2017 real GDP grew 7.0% though inflation had crept back up to 11.1%.
Following Turkey’s and the rest of the world’s recession in 2009 the country reverted back to its bad old ways. “Recep Tayyip Erdogan signed a decree easing access to foreign-exchange loans for Turkish companies. The new rules lifted restrictions that barred companies without revenue in hard currencies from doing such borrowing—as long as the loans exceeded $5 million.” How Erdogan’s push for endless growth brought Turkey to the Brink
Erdogan observed the low interest rates, low inflation, and high growth and apparently concluded that low interest rates caused low inflation rather than the other way around. Every economist knows that interest rates incorporate the market’s expectation of inflation over the period of a loan in order to establish a market clearing real rate of interest. In 1996 when a borrower was willing to pay 130% interest and a lender was not willing to accept less it was because they expected 80% to 90% inflation per annum over the life of the loan. The very high real rate (130% – 80% = 50%) reflects the risk premium of getting it wrong.
Central banks can, if inflation expectations adjust slowly, push real rates down temporarily by lowering nominal market rates below their equilibrium rate. Doing so, however, increases the rate at which the money supply grows eventually increasing inflation and forcing nominal interest rates higher than they would otherwise have been.
Under political pressure from Erdogan, the central bank of Turkey has kept interest rates lower (and thus money supply growth greater) than are consistent with its inflation target of 5%. In the last few years inflation has drifted up reaching 11.1% in 2017. Markets have grown uneasy about the economic situation in Turkey and when the Central Bank failed to increase its policy interest rate last month from 17.75% investors began selling off Turkish bonds and withdrawing funds from the country. Its exchange rate plummeted. From January of this year the Turkish lira depreciated from 11.7 per dollar to 16 lira/USD at the beginning of July and to 21 lira/USD on the 22ndof August. Erdogan’s wrong-headed misunderstanding of the role of interest rates is pushing Turkey over the precipice of bankruptcy.
Meanwhile here in the United States, President Trump apparently attended the same school as Erdogan. After breaking a several decades old protocol against commenting on or interfering with the Federal Reserve’s monetary policy when he stated last month that he didn’t want to see the Fed increase its policy interest rate, he did it again a few days ago. “Trump-escalates-attacks-federal-reserve” Trump’s advice is wrong. The Federal Reserve needs to continue raising its policy rate back toward normal levels (3% to 4%) before inflation momentum becomes any stronger. Real interest rates are still negative (less than the inflation rate). The Fed should have started increasing rates several years earlier.
For as long as I can remember I have purchased food and household items from Safeway, Giant, and Whole Foods without any of them buying anything from me. Was I taken advantage of? Of course not. I voluntarily gave up part of my hard earned income in exchange for something I wanted more. I gained and was made better off by being able to make these trades just as they profited from providing them. In fact, I don’t know and I don’t care what those stores did with the money I paid them. Much of it, of course, was used to buy the goods they put on their shelves for me to buy.
These trades (my income for their goods) would only become a problem if I spent more at Safeway, Giant, and Whole Foods than I earned selling my labor. To do so I would need to borrow money from someone and go into debt. That might be OK temporarily, but obviously not on a permanent basis. In the long run, my purchases (imports) can’t exceed my income (export of my labor).
If you change my name to the United States and the names of Safeway, Giant, and Whole Foods to China, Japan and Germany (not necessarily in that order) nothing in this story changes fundamentally. Americans benefit from our purchases of Chinese goods and it doesn’t matter what they do with the money we paid to them (net of what they purchased from us—i.e., their trade surplus and our trade deficit). As I have explained in the following article, what they (all of them collectively) are largely doing with our money (our net global trade deficit) is finance our profligate government. https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417
For some reason President Trump has trouble understanding these simple facts. He is upset by our trade deficit with China and Germany and others that his profligate, indebted government has caused. If the federal government balanced its budget (actually being at the top of the current business cycle it should be running a surplus in order to balance over the cycle), what would China and Germany do with their surplus of dollars? Rather than buying U.S. treasury securities, they might invest in the U.S. economy contributing to faster economic growth in the U.S. They might also choose to buy more goods and services from the U.S. thus reducing their dollar surpluses. In all likelihood they would do some of each. Given the resulting adjustments in their demand for dollars, the exchange rates of the dollar for Euros and RMB would adjust to produce the desired reduction in their surpluses.
Attacking China with tariffs and demanding a reduction in their trade surplus with the U.S. is counterproductive and wrong headed. But it does not follow that China is playing by the rules (WTO rules that we should be trying to strengthen rather than weaken). The EU, Japan, Canada, Mexico and others share this assessment and Trump would be much smarter to seek their cooperation in pressuring China to behave better rather than attacking them with tariffs and tariff threats as well. With the recent agreement with Jean-Claude Juncker, head of the European Commission, to deescalate the trade war with the EU and resume the negotiations over further trade liberalization started a few years ago (TTIP), perhaps Trump is changing tactics in a more promising direction. This should include concluding the updating of NAFTA and rejoining the TPP now the CPATPP. We should all hope so.
Richard Rahn makes similar arguments in his Washington Times article today: https://www.washingtontimes.com/news/2018/jul/30/the-united-states-is-doing-better-than-it-did-duri/
There seems to be no norm or conventional wisdom that President Trump is not willing to overturn. Following Fed Chairman Powell’s congressional testimony Tuesday in which he confirmed the Fed’s intention to continue its gradual increase in its policy interest rate, Trump said: “I don’t like all of this work that we’re putting into the economy and then I see rates going up.” The statement is wrong on multiple accounts.
The economy is now fully employed and interest rates probably should have been returned to normal some time ago. The alarming current and projected fiscal deficits of the federal government will force interest rates and trade deficits still higher. This is Trump’s fault– not Powell’s. “Who pays uncle Sam’s deficits?” The major policies threatening to undermine the economic boost from tax and regulatory reforms are Trump’s trade policies (pulling out of the Trans Pacific Partnership, stalling and threatening U.S. withdrawal from NAFTA, Steel and Aluminum tariffs (taxes) on our friends in Canada, Mexico and the EU, and a deepening trade war with China). Leaving the TPP Resisting the interest rate increases needed to keep inflation at 2% would increase the most regressive tax around (inflation).
But Presidential interference in implementing monetary policy, as is now being undertaken by President Erdoğan in Turkey, violates a long established principle and practice of central bank independence. Historically, inflation, which falls heaviest on the poor and undermines economic efficiency and growth, has resulted primarily from governments turning to their central banks for financing in misguided and ultimately futile efforts to keep interest rates (government borrowing costs) low.
President Trump can save the economic benefits of his tax and regulatory reforms by rejoining the TPP, rapidly concluding amendments to NAFTA that improve productive efficiency and fairness, dropping the steel and aluminum tariffs, ending the trade war with China, joining with the EU, Canada, Japan and others to bring China into compliance with the rules of a strengthened WTO, and establishing a fiscal budget surplus primarily through entitlement reform.
By Warren Coats[1]
To save financial institutions from the collapse that threatened them after the bankruptcy of Lehman Brothers in September 2008, the Federal Reserve purchased government securities and Mortgage Backed Securities (MBS) sufficient to increase the size of its asset holdings from $0.9 trillion to $4.5 trillion by the end of 2014. These large open market purchases were not meant to increase the money supply, the traditional purpose of such operations, which after a sharp drop followed by a sharp increase in the growth rate of broad money (M2) has grown at its historical average rate of around 6% per year. Rather they were to support the market prices of government debt and hard to price MBS in the face of market panic (at least initially).
The Fed accomplished this trick (large increase in the Fed’s asset holding with only modest increases in the money supply) by paying banks to keep the proceeds of their sales of securities to the Fed in deposits with the Fed, so called “reserves,” in excess of what is required, so called “excess reserves.” Beginning in October 2008, the Fed began to pay interest on bank required and excess reserves deposited with Federal Reserve banks. This kept broad money from growing in response to the huge increases in base money (the counterpart of the securities purchased by the Fed) and became the primary tool of monetary policy.
The Fed is now pondering what to do about its abnormally large balance sheet. A year ago it announced its intention to gradually reduce the size of its asset portfolio in order to return to its traditional policy tools—regulating the growth in bank money and credit by targeting the overnight interbank lending rate (the Fed funds rate) via open market operations. After having suspended the open market purchases that had inflated its balance sheet in recent years (QEs 1, 2, and 3), in October 2017 the Fed stopped replacing the maturing securities it held to the extend of about $20 billion per month. As a result its asset holdings dropped about $150 billion in the nine months since then and by the end of June 2018 stood at $4,315 billion. Its current intention is to reduce its asset holdings to $3 trillion by the end of 2022.
The reduction in the Fed’s holdings of these securities (Treasuries and MBSs) is an increase in the market’s holdings of them, other things equal. But other things are not expected to be equal. Our profligate government is expected to run a one trillion dollar deficit in 2019, adding that amount of government debt to the market on top of the Fed’s additions. The Congressional Budget Office projects a worsening federal deficit every year over the next ten of its official forecast, worsening even as a percent of GDP. This will put pressure on the Fed to rain in or suspend its program to return its asset holdings to more traditional levels.
There is a better way to handle this difficult situation. Bank reserves with the Fed are currently about $2 trillion (the rest of the Fed’s monetary liabilities is Currency in Circulation of $1.7 trillion) and banks’ checkable deposits are about the same amount (of which demand deposits are $1.5 trillion). Requiring 100% reserve backing of checkable deposits was recommended in the 1930s by a group of University of Chicago economists as a way to protect our payment system from the loan default problems being experienced by many banks at the time. This so called Chicago Plan would remove any risks to checkable deposits, a key part of our payment system, and thus eliminate the need for deposit insurance for such deposits. Required reserves would continue to earn interest as they do now, but excess reserves would not. But in addition to strengthening our payment system, adopting the Chicago Plan today would convert existing excess reserves into required reserves and end the debate over whether to further shrink the Fed’s balance sheet.
Adopting the Chicago Plan would prevent banks from on lending our checkable deposits. At the moment they are not doing that anyway. This raises the question of where banks would get the funds (our savings) to on lend in their financial intermediary role? In an extreme version of the Chicago Plan (100% required reserves against all deposits and deposit like bank liabilities) all bank lending would be finance by equity rather than debt. Savers would hold claims on the value of a portfolio of loans as they now do with mutual fund investments and as in some Islamic banking instruments. Equity rather than debt financed bank intermediation is a more stable structure as a result of shifting the risk of loses (loan defaults) from banks to the ultimate public investors. The Federal Deposit Insurance Company would stop insuring 100% reserved deposits and its bank resolution functions would be moved to the Office of the Comptroller of the Currency (OCC) in the U.S. Department of the Treasury.
For purposes of requiring a 100% reserve and dropping deposit insurance, a more pragmatic boundary between all deposit liabilities and checkable deposits might include savings deposits (which can generally be shifted into checkable deposits almost automatically) and time deposits with a maturity of less than six months (or maybe three months). This would add almost $10 trillion dollars to required reserves and would need to be phased in gradually. The Fed would need to buy an equivalent amount of government securities in order to finance the increase in required reserves without contracting the money supply or bank credit.
It is very desirable to separate our payment system (checkable deposits of one definition or another) from the necessarily risky lending by banks and other financial institutions and make our money (currency and deposits) risk free. Doing so would allow banks to take whatever risks with investor funds those investors are willing to finance. This would enable a significant reduction in the government’s regulations of these activities. “Changing Direction on Bank Regulation” Cayman Financial Review April 2015
[1]Dr. Coats retired from the International Monetary Fund in 2003 and is a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.
Warren's space 