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

On April 24, the Australian central bank announced that it would raise the proportion of its reserves devoted to Chinese financial assets from 0% to 5%, likely among the highest such allocations among world central banks.  Will other major central banks follow suit?

It has been widely argued that the Chinese financial markets are too shallow to support such a move and that prospects for rapid internationalization of China’s currency, the RMB, are therefore limited.  But let’s look at the numbers.

According to the IMF, the world holds the equivalent of $10,936 billion in foreign exchange reserves, and $3,442 billion of this is held by China.  That leaves $7,494 billion in reserves for the rest of the world.  If the rest of the world were to invest 5% of its reserves in RMB-denominated assets, that would represent $375 billion worth.  This would make the RMB the world’s third leading reserve currency (well behind the euro, and just ahead of the yen and pound sterling).

According to the Bank for International Settlements, China has the equivalent of $1,248 billion in domestic general government debt outstanding.  So if the rest of the world plowed $375 billion into the Chinese government bond market, foreign official institutions would own about 30% of it.  Is that a lot?

Not compared to what foreign official institutions own of the U.S. government bond market, which is 36%.

Note too that the Chinese government bond market has been growing rapidly; it is nearly 50% larger than it was in 2010.

It remains difficult for foreigners to invest in China owing to government restrictions.  Yet if the Chinese government were to open the doors to foreign central bank investment, its markets could accommodate 5% of world reserves and still have them be less dominated by foreign official institutions than those of the United States.

Beijing Symposium Papers: The Future of the International Monetary System and the Role of the Renminbi
Prasad and Ye: Will the Renminbi Rule?
U.S. Treasury: Major Foreign Holders of Treasury Securities
BIS: Statistical Annex

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

Paul Krugman recently dismissed concerns about America’s large international debt.  “America’s debtor position,” he writes, “isn’t actually that deep, because of capital gains.”

When Krugman talks about “America’s debtor position” he is referring to the net international investment position (NIIP), which is the difference between the value of the U.S. portfolio of foreign assets and the value of the foreign portfolio of U.S. assets.  Krugman demonstrates that the NIIP is fairly flat over the period 2002 to 2010, which presumably shows that concern over U.S. debt is uninformed or disingenuous.  Or does it?

As with Krugman’s “Icelandic Miracle” posts, his conclusion is just an artifact of the starting and ending dates he chooses.  In today’s Geo-Graphic above, note what happens to the trend line when Krugman’s data are brought up to date – adding the data, which he had easy access to, for 2011 and 2012.  Now, the trend is decidedly downward – considerably worse than his.

And what about when we back up the starting date to the mid-1980s, as we do in our graphic?  Now we can clearly see the effect of Krugman’s chosen data period – it wipes off the steep decline in U.S. NIIP before 2002 and after 2010.

Note that in 2009 the U.S. portfolio of foreign securities, which is riskier than the foreign portfolio of U.S. securities, outperformed the foreign portfolio by such a significant margin that the NIIP shrank by nearly $1 trillion – this despite the fact that foreigners continued to buy more assets in the U.S. than the U.S. bought abroad.  This is captured in Krugman’s data.  But in 2011, which Krugman leaves out, this U.S. outperformance was reversed and then some: the NIIP deteriorated by a whopping $1.6 trillion, bringing the NIIP to a record negative $4 trillion.  It continued further down to a record negative $4.4 trillion in 2012.

Which all goes to show that not all graphics are as reliable as Geo-Graphics . . .

Krugman: America the Debtor
Wall Street Journal: For U.S., Big Foreign Investment Is a Mixed Blessing
Chart Book: Foreign Ownership of U.S. Assets
BEA: Quarterly and Year-End Update on U.S. Net International Investment Position

Prominent economic commentators have argued the cases for significantly weaker currencies in each of the world’s major economies – in particular, the United States, the eurozone, Japan, and the UK. As these four economies represent over half of the global economy, it’s clear that they can’t all accomplish this feat. It’s also far from clear that they should all want to.

Take the UK, where the FT’s Martin Wolf has led the charge for “further depreciation of the real exchange rate.” John Maynard Keynes, belying his reputation as a devaluationist, had argued passionately against a weaker pound in 1945 on the basis of terms of trade: that is, the UK would, broadly, have to give up more domestic goods in return for the same quantity of foreign goods. “In [our] circumstances, you can’t imagine anything more foolish,” he said, “than to be trying to sell [our] exports at quite unnecessarily low prices.” Today he might highlight inflation. As shown in today’s Geo-Graphic, currency depreciation is likely to have a much more adverse effect on inflation in the UK than in the United States, the eurozone, or Japan, owing to much higher imports relative to GDP. UK consumer price inflation is already running at a relatively high 2.8%, and the Bank of England’s own analysis suggests that a 20% sterling depreciation risks pushing the price level up 6 percentage points higher than it would otherwise be.

Steil: The Battle of Bretton Woods
Bank of England: Inflation Report February 2011
Wolf: Weaker Pound Is Welcome but No Panacea
Financial Times: Weakening Pound Raises Stagflation Fears

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

President Obama has proposed increasing the federal hourly minimum wage from $7.25 to $9.00, pointing out that 19 states already have minimum wages in excess of $7.25.  Only one state, however, Washington, has a minimum wage above $9.

So what impact would this have?

First, we calculate that this 24% federal hike would increase the effective minimum wage applicable to American labor-force participants, many of whom reside in states with above-federal minimum wages, by 19% on average.  This is substantial.

An important question which follows is what impact this would have on employment.  A recent paper by Texas A&M economists Jonathan Meer and Jeremy West found that whereas the immediate impact on unemployment of raising the minimum wage by 10% is very small, its impact on long-term job growth is more substantial: 0.35 percentage points.  The logic is that raising the minimum wage is a greater deterrent to hiring than it is a motivator for firing.

Using their findings, the 19% rise in the effective minimum wage proposed by President Obama would decrease long-run job growth by 0.7 percentage points.  Put in perspective, this is significant.  Over the past twelve months, average year-over-year job growth has been 1.8%.  Knocking off 0.7 percentage points would reduce it to 1.1%, which is barely more than the 0.9% average year-over-year growth in the labor force over the past twelve months.  As today’s Geo-Graphic shows, this could materially slow the fall in unemployment from its current high level.

Romer: The Business of the Minimum Wage
Salam: A Missing Dimension of the Minimum Wage Discussion
Kimball: Jonathan Meer and Jeremy West on the Effects of the Minimum Wage on Employment Dynamics
New York Times: Jobs to Fill, Employers Wait for Perfection

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

Big-name economists have been lining up to show their support for yet another target-based approach to monetary policy making: nominal gross domestic product level (NGDP) targeting. The basic idea is that a central bank should aim to stabilize GDP, unadjusted for inflation, at around 4.5% as a means of stabilizing aggregate demand and avoiding recessions. NGDP targeting having once been the intellectual stomping ground of economists on the right (notably Scott Sumner), its newest supporters come overwhelmingly from the left (such as Christy Romer).

After the collapse of Bretton Woods in the 1970s, targeting of the money supply became the monetary Holy Grail. In the 1990s, as money supply targeting became operationally too problematic, the world shifted to the targeting of consumer price inflation. But after 2008, when July U.S. CPI hit 5.6% in the midst of a financial crisis, support for inflation targeting – which had become as close to global monetary orthodoxy as the gold standard had been in the late 19^th century – melted away. Credible justification was needed for loosening policy at a time of elevated inflation. A year later, with CPI at -2.1%, such justification was no longer necessary. But those fearing a too-early tightening in policy turned to other targets. Targeting the price level, rather than price inflation, became popular, as it required the Fed to tolerate more inflation in the future to compensate for deflation and under-inflation in the past. The Fed itself has now turned to a temporary unemployment-level target. But NGDP targeting is truly the new intellectual rage. New Bank of England governor Mark Carney is the most prominent advocate in policy-making circles.

We think the rage will be short-lived. The reason is that NGDP targeting’s newest supporters are bad-weather fans. That is, they like it now, when NGDP is well below its 2007 “trend” line, meaning that the policy implies extended and more aggressive monetary loosening. But what happens when NGDP goes above its target, as it eventually will? NGDP targeting then requires tightening, even if inflation is low – it may even require a deliberately deflationary policy stance.

In this week’s Geo-Graphic, we identify in yellow 11 periods between 1983 and 2003 when the Fed was loosening policy but where a 4.5% NGDP target would have prescribed tightening.* This suggests strongly that NGDP targeting has no legs: when it tells the Fed to tighten, its prominent new supporters will abandon it even more quickly than they embraced it. Indeed, two noted monetary economists have even called pre-emptively for the abandonment of NGDP targeting once it’s done its job of justifying looser policy today. “Once the nominal GDP growth shortfall has been eliminated,” Michael Woodford and Frederic Mishkin wrote in the Wall Street Journal on January 6, “ it will be appropriate to again conduct policy much as was done before the crisis.” Yet since the rationale behind both inflation targeting and NGDP targeting is that they anchor public expectations for the long-term, adopting them opportunistically is a particularly bad idea.

* We look at the annual rate of NGDP growth, rather than NGDP levels—using levels would suggest continuous tightening throughout the period and many more yellow bars.

Sumner: The Money Illusion
Romer: Dear Ben: It’s Time for Your Volcker Moment
Steil: The Battle of Bretton Woods
Mishkin and Woodford: In Defense of the Fed’s New Interest-Rate Policy