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The August “jobs report is an important reminder that all this tapering talk is insane and dangerous,” pronounced Slate economics writer Matt Yglesias, reflecting the consensus of the econo-commentariat.  But as today’s Geo-Graphic shows, the report is actually wholly consistent with a September Fed taper. “If the incoming data are broadly consistent with [the Fed’s economic] forecast,” Fed Chairman Ben Bernanke said in June, “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” This was widely interpreted in the markets to mean a September taper, which jibes squarely with subsequent FOMC member comments (and Bernanke’s unwillingness to suggest that it didn’t). The August jobs numbers were slightly weaker than the market consensus expectation, but the fall in the unemployment rate to 7.3% was one the Fed had in June not actually expected to see until the fourth quarter, as our figure on the left shows.  There was therefore no surprising negative news for the Fed in the unemployment numbers. But is the unemployment rate the right number to be looking at?  “With the [labor force] participation rate still falling,” Reuters’ Felix Salmon pointed out, “the unemployment rate is less relevant than ever.” Indeed, the participation rate—the percentage of the population in the labor force—fell in August to 63.2%, its lowest level in 35 years.  As our figure on the upper right shows, however, this decline is wholly on trend with the fall since 2001, and there is therefore no news for the Fed here either—the participation rate is precisely where the Fed should have expected it to be. (The flattening out between 2003 and 2007 was driven by abnormally robust labor demand.  An aging population is over time consistent with a declining participation rate.  See our post from May 21 of last year.) Importantly, as the bottom right figure shows, the decline in the participation rate was also not driven by a rise in discouraged workers—that is, the number of people who would like to work but have given up because of poor job prospects. The bottom line is that if an imminent Fed taper is misguided, as Yglesias, Salmon, and others have argued, it is not misguided because of the August jobs report.  The Fed could not have gleaned anything more negative in it than they would have expected back in June. CBO: Labor Force Projections Through 2021 Bloomberg: Unemployment Falling for Wrong Reason Creates Fed Predicament Kahn: Our Long-Term Unemployment Challenge (In Charts) Wonkblog: Three Reasons the U.S. Labor Force Keeps Shrinking   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

From the beginning of 2009 through this past May 21st, the Fed amassed a portfolio of mortgage-backed securities (MBS) valued at $1.2 trillion.  Over this period, the average 30-year fixed mortgage rate fell from 5.33% to 3.65%, and the spread between that rate and the 10-year government borrowing rate fell from 2.8 percentage points to 1.7 percentage points. Then came talk of “calibration” and “tapering” . . . "Calibrating" asset purchases to volatile data while pledging to ignore data on rates, as we argued recently in Dow Jones’ Financial News, is a tough line for the Fed to walk.  On May 22, and then again on June 19, Chairman Ben Bernanke suggested that the Fed might soon begin reducing the pace of MBS purchases, dependent on developments in the labor market.  Mortgage rates soared.  The average 30-year rate is now hovering around 4.5%; about half the decline in mortgage rates that the Fed had engineered through its multi-year MBS purchase scheme has evaporated. In consequence, the monthly mortgage payment on a $200,000 home purchased with a 10% down payment has risen by a whopping 10% since calibration talk began.  Housing starts also plummeted 10% from May to June, hitting their lowest level since last August, just before the Fed’s latest round of MBS purchases. This confirms our view, expressed recently in the Wall Street Journal, that the Fed should never have gotten involved in sectoral credit allocation in the first place: it should have limited its interventions to the Treasury market, and let the Treasury take politically charged decisions on whether and how to intervene in specific areas of the economy, such as the mortgage and housing markets.  The Fed has only set itself up, as well as the market, for ongoing exit strategy headaches.  Mortgages and monetary policy just don’t mix. Financial Times: U.S. Housing Construction Slides to Ten-Month Low Bernanke: May 22 Congressional Testimony Bernanke: June 19 FOMC Press Conference Wall Street Journal: Thirty-Year Mortgage Rate Posts Largest Weekly Increase Since 1987   Follow Benn on Twitter: @BennSteil

In this chapter preview from Pathways to Freedom: Political and Economic Lessons From Democratic Transitions, Carlos Pio analyzes Brazil’s transition from military rule to democracy and from economic instability to growth and social inclusion.

The Fed is trying to have its cake and eat it too. Having earlier tried to anchor market expectations of future low interest rates by pledging that policy would remain accommodative into 2015, Fed Chairman Ben Bernanke is now saying that the Fed will consider “a recalibration of the pace of its [asset] purchases . . . in light of incoming information.” So what’s Mr. Market to do? Sleep tight and let the data do what the data will do, or pounce on data rumors to front-run the “recalibration”? The Fed’s trying to fine-tune the pace of asset purchases is bound to give Mr. Market a bad case of the shakes, as “incoming information” has been extremely volatile throughout this economic recovery. As today’s Geo-Graphic shows, using the six-month average of employment gains to project the unemployment rate going forward suggests vastly different metrics of how close the Fed is to achieving its 6.5% unemployment-rate objective. If the average pace of job gains in the six months leading up to and including the March unemployment report had been extrapolated forward, the Fed would have expected to reach its 6.5% unemployment target in August 2015. Yet with just one additional month of employment data, an extrapolation of the six-month average gain in employment through April shows the unemployment rate falling below the committee’s 6.5% threshold in August 2014, a full year earlier. And the pattern over the past two months is not an anomaly. Using the six months of employment data available in November of last year, our projection had the Fed reaching its employment objective as soon as May 2014; but in January of this year, just two months after the November unemployment report, our projection doesn’t have the Fed reaching its objective until September 2015. Asset purchases are not a precision tool, so the idea of continuously “recalibrating” them to volatile economic data is a particularly bad one. Recalibration is a strategy in need of recalibration. Financial Times: Ben Bernanke Says Bond Buying Could Slow Wall Street Journal: Fed Leaves Market Guessing The Economist: Parsing the Federal Reserve The Guardian: Markets Rally as Ben Bernanke Backs Further Quantitative Easing   Follow Benn on Twitter: @BennSteil

Benn’s new book The Battle of Bretton Woods has been called “the gold standard on its topic” by the New York Times, “a triumph of economic and diplomatic history” by the Financial Times, and “a superb history” by the Wall Street Journal.  But Eric Rauchway is having none of it.  He’s dinged the book twice now, its only two negative reviews—first for the IMF’s Finance & Development and then, in an extended dance remix version, for the TLS. Wade through the snark-infested waters, and you’ll find that Rauchway has two substantive complaints: that Benn doesn’t understand the gold standard, and that he bases his account of Harry Dexter White’s role in the crafting of the FDR administration’s 1941 “Ten-Point Note” ultimatum to Japan on “fake” documents.  Serious stuff. So let’s start with gold.  “Contrary to Steil’s account,” Rauchway writes, “monetary gold stock did not generally move across borders.” Now Rauchway is not an economist, but presumably he can read. During “the years 1880-1913,” Benn writes on page 20, “governments around the globe had allowed an unprecedented degree of activity within and between their nations to be regulated by the market-driven transfer of gold claims across borders (the physical stuff itself just shifted around in central bank vaults).” Whoops.  Next? . . . Rauchway quotes Benn as writing that Bretton Woods was “an economic apocalypse in the making.” Here, dear readers, is what Benn actually wrote on page 334: “Harry White’s creation, in [Robert] Triffin’s rendering, was an economic apocalypse in the making.” Get a sense that there’s a pattern forming here?  Moving right along . . . Rauchway takes specific issue with Benn’s claim that under the classical gold standard “when gold flowed in [the authorities] loosened credit, and when it flowed out they tightened credit,” arguing that this is “at odds with historical evidence.” Oh? Today’s Geo-Graphic provides the historical evidence.  Let’s see what it shows . . . During what Rauchway describes as “the heyday of the gold standard,” we can in the top two figures see that long interest rates did indeed tend to rise when gold was flowing out of the United States and fall when gold was flowing in.  This is particularly clear in the 2-year moving average figure on the right. Rauchway goes on to say that theoretical models which have countries losing gold when they import more than they export were not realized in practice. Really? Check out the bottom two figures, showing the relationship between net gold movements and net merchandise imports.  Again, the relationship is exactly what Rauchway denies: net merchandise exports tend to move with net gold imports, which is, again, particularly clear in the 2-year moving average figure on the right. Economics lesson finished.  On to history . . . The Battle of Bretton Woods, according to Rauchway, claims that “[Harry Dexter] White caused the attack on Pearl Harbor.” Uh, no. Benn’s book claims that White authored the key ultimatum demands contained within the Ten-Point Note (and not the entire “Hull memo of November 26,” as Rauchway wrongly puts it), and that a wartime Soviet intelligence operation codenamed “Operation Snow” was engaged to motivate White, with the aim of “provok[ing] war between the Empire of the Rising Sun and the USA and to insure the interests of the Soviet Union in the Far East,” according to GRU military intelligence colonel Vladimir Karpov.  Benn writes on page 58 that “The significance of Operation Snow lay not in White acting as he did because he was so prodded, and certainly not in acting against what he believed to be American interests; rather, it is that the Soviets believed that White was influential and impressionable enough, and that conflict between the United States and Japan was important enough, that they chose to use him in pursuit of their aims.” Rauchway writes that Benn’s “historical backup [is] a book by Jerrold and Leona Schecter called Sacred Secrets (2002).” He then invokes historians John Earl Haynes and Harvey Klehr to argue that “the documents on which the Schecters relied for their discussion of White” are “fake.” Oh boy . . . After reading Rauchway’s TLS review, Haynes and Klehr wrote the following to the journal’s editors, which was published on April 26: We are flattered that Eric Rauchway mentioned our article in Intelligence and National Security (October 2011) in his review of Benn Steil’s The Battle of Bretton Woods.  In that article we noted the use of what evidence indicated were faked documents in Gerald and Leona Schecter’s Sacred Secrets.  (We assume the faked documents were foisted on the Schecters by unscrupulous Russian sources.)  We are also flattered that Steil relies heavily on our work on White’s espionage.  But, our account does not, as Rauchway suggests, undermine Steil’s story of White’s treachery or imply that he was bamboozled by fake documents.  In fact, Steil cites the Schecters only once in his whole book. Ouch. Foreign Affairs: Red White Standpoint: The Moneybags and the Brains Bloomberg Echoes: How Dollar Diplomacy Spelled Doom for the British Empire NPR: Examining Bretton Woods

The Governing Council of the European Central Bank meets on May 2, with a possible rate cut in the offing. Yet a rate cut is not the no-brainer the Bank’s critics often suggest, as today’s Geo-Graphic shows. The ECB’s official inflation-rate target is “below, but close to, 2%.” Both Portugal and Greece have inflation under 1% , but the transmission mechanism from ECB rates to business borrowing rates in those two countries has been virtually severed by the crisis. In short, they need a rate cut, but the ECB can’t deliver them one. In those Eurozone countries where the monetary transmission mechanism is still working normally—Austria, Finland, France, Germany, and the Netherlands—the GDP-weighted-average inflation rate is 1.8%, right near the ECB’s target. France, with 1.1% inflation and 10.8% unemployment, would appear a strong candidate for a rate cut, but not the others. Germany has 1.8% inflation and only 5.4% unemployment. The other three all have above-target inflation rates: Austria at 2.4%, Finland 2.5%, and the Netherlands 3.2%. Austrian unemployment is low, at 4.8%. Dutch unemployment is a moderate 6.4% Only Finnish unemployment is high, at 8.2%. Some will argue that a bout of robust inflation in the north is just what is needed to restore competitiveness in the south. But the ECB will have to willfully ignore its price-stability mandate if it is to justify a rate cut right now, and it will almost certainly need to apply more radical tools if it is to aid the south quickly. “The ECB is obviously in a difficult position,” German Chancellor Angela Merkel said on April 25. “For Germany, it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing.” Yes indeed. This is Draghi’s Dilemma. Geo-Graphics: Is the ECB Draining Its Own Powers? Financial Times: Merkel Speech Highlights European Divide Reuters: Merkel Says Germany Would Need Rate Rise Wall Street Journal: Bleak Europe Data May Prompt ECB Action

China has since 1994 operated some form of currency peg, harder or softer, between its yuan and the U.S. dollar. While China’s state-run Xinhua news agency has in recent years railed against U.S. management of the dollar, and has called for “a new, stable, and secured global reserve currency,” this week’s Geo-Graphic illustrates why China has little incentive to press for such a thing. During the 1956 Suez crisis the Eisenhower administration threatened to create a sterling crisis in order to force Britain out of Egypt. A collapse in sterling would have caused minimal collateral financial damage in the United States owing to trivial U.S. government holdings of British securities – amounting to just $1 per U.S. resident. In contrast, China’s holdings of U.S. securities today amount to over $1,000 per Chinese resident. Any major fall in demand for dollar-denominated assets would cause a collapse in the global purchasing power of China’s massive dollar hoard. For its part, the United States finds congenial a world in which a dollar sent to China for cheap goods comes back overnight in the form of a near-zero interest loan, which can then be recycled through the U.S. financial system to create yet more cheap credit. Neither partner in this monetary marriage is, therefore, likely to file for divorce any time soon. Steil: Red White Steil: The Battle of Bretton Woods Eichengreen: Exorbitant Privilege Treasury: Report on Foreign Portfolio Holdings of U.S. Securities Xinhua: U.S. Must Address Its Chronic Debt Problems

Last week’s Bank of England (BoE) poll of UK lenders turned up some good news: credit “availability” for both households and companies is on the rise – as we document in the upper right figure of today’s Geo-Graphic.  The Old Lady of Threadneedle Street was quick to take credit for the credit: “Lenders noted,” crowed the BoE, “that the Funding for Lending Scheme,” through which the BoE and UK Treasury have since August provided banks with cheap funds to boost their lending, “had been an important factor behind this increase.” The survey the BoE referred to should be considered about as reliable as LIBOR, which, as we know, has been subject to systematic manipulation by major international banks over recent years.  The indexes of credit availability the BoE has manufactured from its surveys are similarly unreliable, as the banks have every incentive to convince the BoE that FLS is working, and that cheap government funds should keep flowing to them.  Actual UK lending, however, as our bottom two figures show, remains depressed. Not surprisingly, given tight lending conditions in the U.S (see the upper left figure), Fed Chairman Ben Bernanke has said that he is “very interested” in the scheme.  This has stimulated market expectations that the Fed might try to launch something similar in the United States.  The Fed should hold its fire. Bank of England: Credit Conditions Survey 2012 Q4 Fed: October 2012 Senior Loan Officer Opinion Survey on Bank Lending Practices Bernanke: June 20, 2012 Press Conference Financial Times: Credit Conditions Ease "Significantly"

The United States marches solemnly towards its fiscal cliff, awaiting only the command from the Goddess of Reason to halt. Unfortunately for Greece, that country plugged its ears back in March. Like the United States, Greece made prior commitments on spending and taxation in order to bind itself to the mission of deficit reduction. Unlike the United States, Greece left itself little means to unbind itself. As shown in the graphic above, its massive debt restructuring in March only reduced its debt-to-GDP ratio from 170% to 150%, but in the process made further significant restructuring much more difficult. Before the March restructuring, Greece owed private sector creditors €177 billion in obligations governed by Greek law and only €30 worth governed by international law, the latter being vastly more difficult to walk away from. After the restructuring, Greece owed private sector creditors only €86 billion, but all of it was now governed by international law (31.5%*177 + 30). And it also added €75 billion to its €124 billion stock of official sector (EU and IMF) obligations, bringing that total to a whopping €200 billion. Though Greece desperately needs to shed more debt, it faces the problem that its private sector creditors are now all shielded by international law, and its public sector creditors are protected by the power to hurl it into unsplendid economic and political isolation. This suggests strongly that Greece should simply have repudiated all its Greek-law private sector debt back in March, when it had the chance. Why didn’t it? Many reasons, some of which flimsy – such as fears of triggering credit default swaps if the restructuring were “involuntary.” But the most pressing reason was to avoid crushing the Greek banking sector, which was exposed to Greek sovereign debt to the tune of about €50 billion. The €25 billion lent to Greece by the so-called European Financial Stability Facility (EFSF) in order to recapitalize its banks would then have to have been a much higher €50 billion. Still, Greece would be at considerably less risk of hurtling over the fiscal cliff today had it avoided taking on the additional €56 billion worth of nonrepudiable private sector IOUs in March. In contrast, the United States can avoid its looming cliff by Congress and the president agreeing just to keep on adding to the prodigious national tab. It’s good to be the king of reserve-currency issuers - at least until the market cuts your head off. European Financial Stability Fund: Questions and Answers IMF: Greece's Financial Position in the Fund as of Sept. 30 BIS: Consolidated Banking Statistics Geo-Graphics: The IMF Is Shocked, Shocked at Greece's Fiscal Failure. Should It Be?

While a new round of U.S. quantitative easing will have a negative impact on emerging markets like Brazil, the country should not blame U.S. monetary policy for the structural flaws in its economy, says expert Bernardo Wjuniski.