Tuesday, March 31, 2015

What's Natural?

                               "Hey bro, betcha I can chug this between 0.00 and 0.25 seconds!"

We hear the word 'natural' all the time in our busy modern lives: natural remedy, natural ingredients, all-natural, natural grains, etc. However, as any savvy shopper and/or reader of Consumer Reports knows, the word "natural" has no meaning when applied to consumer products. There is no one industry or governmental definition or standard of what consists of "natural", so corporations can, and do, freely slap the "natural" label on just about anything they want.

However, this blog post isn't going to be about lying advertisements, because I don't have the rest of the decade to sit at this computer. No, this post is about the annoying tendency of economists to use the word "natural" in their field of study, even though it almost never applies. Economics is a study of human systems; systems that have been deliberately contrived in some way or another by human activity. Nothing about economic systems are natural, since both property rights and currency, the two building blocks of any "market" system, always have a governmental orgin. The structure, distribution, and quantity of property rights and currency are dependent on government policy, and by proxy, the people who hang around the halls of power when these policies are made.

So it was with slight annoyance/great frustration/indignant fury/neurotic hysteria that I read this recent blog post by former Federal Reserve Chair Ben Bernanke. It seems Bernanke is the latest of the Bearded Economists (BE) to join the blogosphere (welcome Ben!), but unfortunately he got off to a bad start. In his very first day of blogging, he decided to dive into the topic of what the "natural" rate of interest is, and the economic theories that compete to decide what this "natural" rate is. No amount of verbal contortions could get Bernanke around the fact that there is simply no such thing as a "natural" rate of interest on currency, for the simple reason that currency itself is not natural. US Dollars don't fall out of the sky or grow on trees, nor did they ever shoot out of the end of Moses' staff. Currencies are simply the products of the entities that issue them, governmental or not. As long as the issuer of said currency does not promise to convert that currency, on demand at some fixed rate, into something else, than that currency has no natural "own" rate, aka interest rate.

Just like the letters in this sentence, US dollars cost nothing to produce. They are merely typed into existence by government employees. Therefore, they carry no "natural" rate of interest or growth, any more than the letters in this sentence can naturally grow. When I come back and re-read this blog post in 6 months, it will have the same amount of letters in it (unles i mak sum editts, off cours). This also happens to be the case with my savings account-- barring any deposits/withdrawals, the balance in my savings account will have the same amount of dollars in it in 6 months, because the rate of interest paid on that account is so low that it only amounts to a few dozen cents per year. This is not because the "natural" rate of interest on my savings account has changed, or there is something unusual about Wells Fargo Account #2248-955118-89! (not my real account number). This is simply because the Federal Reserve, you know, that organization that Mr. Bernanke used to be the head of, has decided that current interest rates should be next to zero. And while I happen to like this zero rate policy (because I believe that no one is entitled to earn any particular rate of interest on federally insured bank deposits that just sit around doing nothing), I don't pretend that it is in any way "natural."

This near zero rate is not any more or less natural than if it was, say 18%, as it was during the Paul Volcker days. Although Volcker raised rates this high in order to destroy labor unions, the middle class, America, etc. nobody claimed that they were "unnatural." The rate in 1982, as it is now, was just policy choice like any other. It wasn't delivered to them by Jesus. The men and women (ok, mostly men) on the FOMC just pick a number for the overnight interest rate and tell the New York Fed to fiddle around on their computers until that becomes the rate. If the government wants the interest rate on its own liabilities (US dollars) to be zero, than it can be zero; if it wants the rate to be 40%, it can be 40%.  Neither rate is natural.

Going a little deeper, the Wicksellian Monetarists, of which Bernanke appears to be one, believe that at any one time there is a "natural" rate of interest that will lead to full employment. A few of the obvious problems with this Wicksellian or IS/LM theory are that-

1) it was devised under a gold standard economic system which was completely different and no longer exists

2) no one can seem to agree what full employment really is

3) what employment metric do you even use to define "full"

4) We now live in a world with fiat currencies, and computers, and global trade, and robots, and a global labor force, and highly interconnected banking systems, and, and, and.....

One sentence of his blog really set me off, however. According to Mr. B,

"Government spending and taxation policies also affect the equilibrium real rate: Large deficits will tend to increase the equilibrium real rate (again, all else equal), because government borrowing diverts savings away from private investment."

Hmmm how about that? If anything, the trend lines during Bernanke's economic career would indicate THE OPPOSITE:

Thankfully, Mr. Bernanke did get some things right, like saying that the Fed has no choice but to set SOME short term interest rate. However, as far as I can tell, he didnt take the next step and assert that the Fed's short term rate influences the entire yield curve of both paper and capital markets (the latter less directly):

And that's just the effect of the federal funds rate changing. What Bernanke doesnt say is that the Fed can (and has, in the Eccles era) target any point along the yield curve it wishes. It can announce price targets and buy/sell till that target is hit, or simply offer its own long-term term deposits at some rate. For example, if the Fed wanted to set the floor for 30-year mortgages at 8%, it could offer 30-year term deposits at 8%, ensuring no 30-yr mortgage would ever be issued at less than 8%.

So if your forehead has not yet connected with your desk, you are now better at macroeconomics than most of 'em. Now go have yourself a cool, crisp, refreshing* can of Natural Light.

*disclaimer: It is none of these things**

**things includes "beer"