What is the target?

money targetInsanity has often and aptly been described as

“…doing the same thing over and over again while expecting a different outcome.”

If this is, indeed, insanity then it is sadly too common in human behavior—especially in our convoluted system of money, credit and banking.

Depending upon what we read and to whom we listen, we are told that the Fed is following its monetary policy with the goal of stabilizing the broad price level, reducing unemployment, raising economic growth, dampening euphoric credit markets, reducing the impact of terrorism, stimulating bank lending activity, absorbing ballooning government debt, stabilizing foreign exchange rates, guarding the economic recovery, taming commodity prices, etc.

At the same time, looking at the private banking system we were told that the recent credit bubbles were due to excessive lending and poor underwriting of loans—too many mortgages to too many weak borrowers, too many unsecured personal loans, and too many loans to weak and speculative businesses.  Now we are told that banks are too reluctant to lend the unprecedented flood of liquidity from the Fed.  Like “deer in the headlights” they are simply accumulating and holding “excess reserves” while frustrated borrowers get little or nothing.  To our amazement, this last statement was actually validated by the recent observation that currency held by the public and within banks actually exceeded the so-called M1 money stock, total currency held by the non-bank public plus all checking accounts.  Clearly our current money and banking system is badly broken.

But, in truth, since its inception in 1913 it has never worked well.  It has always been racing around trying to put out spot fires largely due to its own previous policies.  Despite all the political pressure applied to the Fed and its Chairman, if you have but one policy variable, money growth, you can logically have only one target.  However, our monetary system is designed to fail. Irresistible political pressure always forces it to chase many and changing targets.  On top of this, the additional uncertainty of private bank lending, or the lack thereof, also works to ultimately determine the size of our money supply.  This makes it impossible for the Fed, even with the best intentions, to actually control monetary growth.

What should be the over-riding goal of money is to be a trusted store of real value—the very instrument of wealth we would prefer to hold over time.  As a benchmark of valuation and pricing of other goods, it should be simple, logical and understandable.  Its supply should be derived from the needs and desires of a private market and not the child of a policy intended to micro-manage the economy or generate a covert inflation tax to the government.  We need to break the cycle of insanity.  That is why we need productive capital as money.

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  1. Eamonn said:

    Former Fed Chairman Paul Volcker famously said that the only useful innovation to come out of the financial industry in the last 30 years was the cash machine. He also said, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.” Rare words of wisdom from a Fed Chairman, and he raised an important issue. When banks originate loans but do not hold them, it motivates them to pump as much of the crap out as they can, especially when times are good, the underlying properties are rising in price, Uncle Sam guarantees them and ratings agencies bless them as AAA. We have a situation now where most people keep the bulk of their net worth either in housing (an illiquid consumer-durable, not an investment) or in a 401(k) plan (which is essentially a gamble that tax rates will be lower in the future and you will not need the money before retirement, limited investment choices).

    The asset securitization model was a criminal enterprise in my opinion, and the aftermath is being papered over with more crime, this time in the form of phony “mark to fantasy” accounting standards, QE where the crap is being transferred from the banks to the citizens, the coordinated metering of housing inventory, and even looser mortgage standards where the government now guarantees 90%+ of new housing loans. Aside from Bernie Madoff, not a single financial criminal is wearing an orange jumpsuit. As the article notes, we do not suffer from lack of liquidity by money supply metrics, we suffer from lack of the rule of law and capital impairment: if we reintroduced accounting standards much of the US banking system would be recognized for the insolvent pig that it is. It is a banana republic -style financial system; alas, I am not referring to the clothing store.

    And this uncertainty about the true value of things is a great problem today. It is why we are mired in such a mess 5 years after the problem first surfaced. The Federal Reserve has juiced virtually every financial asset class to overvaluation. But if you believe in the market as I do, eventually they will fail and things will come back down to earth. At current valuations of 23.4 Shiller PE versus the long-term median of 16, due of course to banking shenanigans, the average expected 10 yr. real return is 0.9%. Better of course than parking cash in a 0% passbook account minus inflation, but what is sacrificed in opportunity cost? The Fed will continue to support the equity markets until the last drop of retail mom-and-pop money comes in. Ol’ mom-and-pop have a bad habit of buying at the top and selling at the bottom, as many did in March 2009. There is of course the outside chance that there will be high or hyper-inflation from the money printing in which case you may want some equity exposure, but the risks as of today (2/13/13) are to the downside. The closest parallel I see to our current situation is Japan, which experienced a similar real estate bubble in the late 1980s, followed for the last 20 years by endless QE and stimulus (infamous bridges to nowhere) propping up their zombie banks rather than letting markets do what markets do best: clear out that which is unsustainable.

  2. Dwayne said:


    Interesting and thought-provoking comment.

    I agree that the Fed is presently working mighty hard to create some new asset bubbles.
    Also, recently released data suggest that mom and pop are following your suggested behavioral script, now moving portfolios from bonds to equities. (Watch out below??)


  3. Eamonn said:

    Dwayne, I have heard that too. Oftentimes the last phase of bull market runs is signaled by a rise in interest rates like we have seen of late, albeit off very low levels.


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