Central Banks And Politics

We thank many readers for their emails, rebuttals, affirmations, and confirmations regarding our discussion of the Fed’s decision not to taper and our view that it injected another level of politics into central bank decision making. Some readers said no; they thought that the dysfunctional Congress was already churning the markets and that the Fed’s course of action, or its lack of action, had nothing to do with market volatility following Ben Bernanke’s announcement and ensuing comments by other members of the Fed. Others observed that volatile markets shifted from positive surprise at the news of no taper to negative discourse after some Fed speakers began to imply that the meeting decision was a very close call and could be reversed quickly. Still others blame the markets’ volatility and Friday’s sell-off on Speaker Boehner’s press conference alone. And others faulted the 40 or so Republican Congressmen who are hell-bent on defunding and overturning ObamaCare regardless of what their crusade might do to the US economy.

Of course these things are difficult to measure. I mulled the list of political outcomes, and the mulling kept me up all night. In fact, it was such a wakeful night of workful thinking that I got up early in the morning, went to a Chinese restaurant, and ordered food. When it was served steaming, something was not right. The fact that it wasn’t bacon and eggs wasn’t the problem. So maybe I surprised the staff when I asked them to put my food in the refrigerator so it would get cold. But everybody knows that cold Chinese food is what’s for breakfast after an all-nighter. And somehow politics and central banking mix in such a way that indigestion seems the order of the day.

Looking around the world, we see politics swaying the major central banks in the biggest way we can recall. Politics are certainly involved in the actions of the US central bank. We have discussed that many times. Since the financial crisis, the Fed has had to fund agencies of the federal government that do not go through an appropriation process. The Fed now turns its “profits” over to the US Treasury and therefore has a budgetary impact based on its monetary policy. We do not understand why these are deemed profits. My colleague Bob Eisenbeis, Cumberland’s Chief Monetary Economist, has already written about that concept. But they are called profits and therefore have become profits, if terminology can make them so. What happens to the federal budget and politics when the profits no longer exist is another matter.

With political change in Japan and resulting appointments, we see the Bank of Japan now engaged in a different policy approach. We see the throes of politics often derailing the attempt Japan’s political leadership is making to weaken the yen without saying that they intend to do so.

We see politics of the German election and the German system influencing policy at the ECB (European Central Bank). Chancellor Angela Merkel has been decisively returned to power, but her Christian Democratic Union will likely have to form a "grand coalition" with the center-left Social Democrats, which could further hinder the formation of a Eurozone-wide "banking union." (See http://stream.wsj.com/story/markets/SS-2-5/SS-2-334553/.) Recall, too, that Germany is the largest weight in the Eurozone and in the capital structure of the ECB. Certain decisions about what the ECB can and cannot do in the operation of monetary policy will be strongly influenced by the findings of the German Constitutional Court, which is expected to come to a decision soon on the legality of the ECB's Outright Monetary Transactions (OMT). (See http://www.theforeignreport.com/2013/07/05/germany-the-constitutional-court-will-decide-on-the-future-of-the-eurozone/.)

Politics and central banking have hobbled forward together for many years. That one should find itself tethered loosely or tightly to the other is nothing new. Whether Democrats or Republicans, presidents who do not like what Fed chairmen do have bashed and criticized them, suggesting in one form or another that the chairmen change their policies.

At key points in history, the central bank has engaged in policies that were driven by politics but were extremely patriotic. During the World War II era, for 4 years the Fed held the short-term interest rate at 0.375% on 90-day Treasury bills and at 2% on long-term Treasury bonds. The Fed was completely committed to the funding of US defense forces. It did not make the decision to be in a war or to avoid a war, but it subsumed any independent policy making to the cause of prevailing when the US was at war.

One can see there are times when politics and central banking function well together. The country rallied during World War II. Patriotism was high. The need to defend the country was understood by the citizens. The central bank set aside all independence and struck a course to help the US win the war, lining up behind the cause just as American men lined up to enlist and Rosie went to work making rivets.

But, when agendas of US politicians do not converge in the national interest and do not have the full or broad support of the country, problems arise when politics intervene in the conduct of central banking. In the US today, 325 million people are concerned about their healthcare, the funding of healthcare, the operation of their government, the funding of the operation of their government, as well as hundreds of other federal issues that impact their lives and the future of the nation. The diversity of opinion is obvious in the structure and composition of our political bodies in Washington, DC. Yet during this period of intense and divisive debate in our country, we see a small number of our political representatives trying to enforce their views at any cost and regardless of the outcome.

Their agenda is not about patriotism, a broad consensus service, or a view prevalent among the mainstream of the American population.

In such circumstances, when the Fed acts in a way that is counter to expectations it has created by means of its own presumably calculated rhetoric – rhetoric which markets have, after a series of convulsions and gyrations, come to accept – then the central bank has succeeded only in missing the opportunity for what we might call a free shot. There was no one standing in the way. The markets had already priced in an expectation, and that expectation reflected the direction that the central bank has to take sooner or later anyway.

The bewildering aspect of the Fed’s no-tapering decision really boils down to why, in a very close decision, they opted not to take that free shot. In explaining their actions, they alluded to the political impasse, thus creating an opening for the very politicians who are engaged in furthering that impasse to pass some buck: Congressmen embroiled in this debate can now point to the Fed’s delay as the cause of market reaction instead of pointing at themselves.

This follow-up commentary is an attempt to explain or embellish a point of view. Again we thank readers for their comments, emails, and discussions. Politics is a very sensitive and difficult subject to discuss under all circumstances. But politics and central banks entwined are a dangerous proposition. No matter what the outcome, detractors will be sharply critical. As outcomes progress, so will the indigestion. Just like the cold Chinese food from early this morning.