Financial Markets

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

Last week, I wrote on the ECB’s meeting and the case for easing credit conditions in the periphery (a recommendation that they didn’t heed, though pressure to act is building).  I ignored the upcoming Bank of Japan (BoJ) meeting.  My wife’s comment the next day summed it up well:  “you blogged on the wrong central bank.” For those that don’t follow central banking closely, it’s worth a moment of reflection on why what the BoJ did last week was so important. In his first meeting as central bank governor, Mr. Kuroda produced a package that easily meets an economic “Powell Doctrine” test–having exhausted all the other options, it brings overwhelming force to bear in order to change expectations for financial conditions, inflation, and growth in Japan. The Bank adopted a price stability target of 2 percent for the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. To get there, it targeted a doubling of the monetary base (the previous target was the overnight interest rate), an annual increase of 60 to 70 trillion yen. It will double its holdings of Japanese government bonds (JGBs) as well as exchange-traded funds (ETFs) in two years (a net purchase of around ¥5 trillion per month), and more than double the average remaining maturity of JGB purchases.  The decision to purchase bonds of longer maturity gets the BoJ more bang for the yen then if they had stuck to the old practice of focusing on short-duration bonds. Scaled for the economy, this is not that much different from what the Fed has done and twice the current pace of Fed purchases. The Bank is committed to continue with its quantitative monetary easing as long as necessary to achieve these targets. At some level, this should look familiar as it in substance mirrors the non-conventional easing strategy followed by the Fed in recent years in its combination of purchases of longer-duration assets with a commitment to maintain such policies for longer than markets might otherwise expect.  In the presence of a liquidity trap, the key to making quantitative purchases effective is to credibly promise to raise inflation, and this effort goes in that direction.  Some also are comparing the action to Paul Volcker’s anti-inflation policy of 1979.  Like that experiment, the Bank of Japan recognizes the uncertainty in how the experiment will play out and, by shifting to a monetary base, signals its willingness to accept whatever rates are needed to reach their quantitative targets. It’s a major break with past policy, and that is the central point:  the new policy represents a fundamental shift in the paradigm that has guided Japan monetary policy for the last 25+ years.  Since the bubble of the late 1980s, economists have criticized the BoJ policy as too tight, too tentative, and too willing to tighten prematurely when green shoots of recovery appeared.  BoJ staff repeatedly justified their policies with the argument that deflation in Japan was structural, a function of demographics and the special characteristics of Japan’s economy, and thus outside the ability of the monetary policy to reverse.  Last week’s package of measures, adopted unanimously (some of the measures were rejected by an 8 to 1 vote last month), represents a repudiation of that view. The effect of the announcement on markets–a sharp decline in the yen from below 93 per dollar earlier this month to 98.9 currently, an increase in the Nikkei, and strength in a range of other currencies whose markets are expected to benefit from Japanese capital outflows–was dramatic and is likely to continue to percolate this week.  The IMF and key central bankers saluted the action, while others expressed concern about the yen’s depreciation.  Whether this is the green light to “currency wars” and capital controls that bubbled to the surface at last months’ G-20 meeting remains to be seen. What the Bank of Japan did last week is an important moment.  It also puts in sharp contrast the inadequacy of the ECB’s approach to ending deflation pressures in Europe.

European Central Bank president Mario Draghi has promised to do “whatever it takes to preserve the euro,” and the bank’s Outright Monetary Transactions initiative last September, aimed at pulling down crisis-country bond rates, no doubt calmed market fears of a eurozone breakup. But whereas eurozone sovereign bond spreads have narrowed, the gap in real economic performance – particularly unemployment – between the best and worst performers, as shown in today’s Geo-Graphic, has continued to grow precipitously. Compare this to the United States, which has a fiscal and banking union as well as a monetary one. There, jumps in unemployment rate dispersion across states caused by financial and other shocks are reversed in relatively short order. Draghi: "Whatever It Takes" Bini Smaghi: Ireland Points Way for Cyprus and Euro Periphery IMF: Europe Needs Banking Union Bordo, Jonung, Markiewicz: Some Historical Lessons on Fiscal Union

As part of a book I’m working on, I’ve spent some time wading through the econometric literature on speculation in commodity markets, oil in particular. This body of research tries to shed light on how the inflow of investor money into commodity derivatives over the last decade has affected these markets. I’m skeptical of a lot of what’s out there on this topic, though there is also some excellent work, too, like from Bassam Fattouh at the Oxford Institute for Energy Studies. Unfortunately, much of the research on this topic doesn’t withstand close scrutiny. It’s not for a lack of smart people trying. I see it mainly as a data problem. The statistical methods used are often sophisticated, yes. But the publicly available data about global oil flows, including stockpiling, are far too limited, and not nearly internally consistent enough, to make it easy to form solid, actionable answers to many of the questions regulators have been trying to answer. It’s true that some research suggests changes in certain aspects of market behavior as the profile of market participants has evolved. Here’s an example. Jim Hamilton and Cynthia Wu made a compelling case in a working paper last year that risk premia in crude oil futures prices have changed since 2005, which they ascribe mainly to the inflow of financial-sector capital (see the figure below). Source: Hamilton and Wu, 2012 They may be right. But regulators should beware of drawing the wrong lessons from studies like this one. Fluctuations in risk premia are relevant to oil traders, but not necessarily relevant to normal people, whose focus is on how much they pay at the pump. A change in one aspect of the market (in this case, derivative risk premia) does not necessarily cause a problematic or unfair change in other aspects, like retail prices. Yes, the two can at times be linked, but not always. Sensible regulation in commodity markets doesn’t seek to impose stasis on what should be a dynamic, evolving market, but rather to respond to structural changes that undermine the utility of these markets, their function as a means of price discovery, and their role in the economy more broadly.

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