Recently by Robert Wenzel: Fed Economist Who Called Ron Paul a Pinhead Isn’t Even an American

Stephen Williamson, another Fed economist from the same Fed branch, the St Louis branch where another economist, David Andolfatto, called Congressman Ron Paul a pinhead is out with a clarifying rant.

He starts his rant by telling us that:

I have worked full-time at the Minneapolis Fed (2 years), and have been a visiting academic at the Federal Reserve Banks of Richmond, Cleveland, Philadelphia, Kansas City, Atlanta, and New York. I currently spend an average of something less than one day per week at the St. Louis Fed, in my hometown, where my full-time job is at Washington University in St. Louis. My title at the St. Louis Fed is "Research Fellow," and I have an office over there (no window unfortunately) with my name on the door. I also know some powerful people. I went to graduate school with 2 Fed Presidents, know 4 Fed Presidents well (Narayana Kocherlakota is a rather aggressive poker player; Dean Corbae is not), and am an acquaintance of Ben Bernanke’s from back in the day (e.g. we both belonged to Glenn Hubbard’s NBER group for a time).

I am not trying to boast here.

He then goes on to attack some of Ron Paul’s specific points:

1. The Fed is immoral. The idea here has to do with what Paul calls "printing money out of thin air." We have a government, and the government is a tyrant. The tyrant must confiscate resources in order to keep itself alive….Is the Fed immoral? Ron Paul wants you to think that what the Fed is doing is mysterious, secretive, and underhanded. We have all been hoodwinked but, according to him, he has figured it out, and will proceed to enlighten us. You can forgive Paul somewhat for the "printing money out of thin air" idea, as this is part of what is conveyed in conventional money and banking undergraduate courses. Indeed, Paul’s exposure to formal economics training appears to be confined to a single undergraduate course, in which he seems to have been exposed to the money multiplier, probably the most misleading idea propagated in monetary economics

He then argues:

As discussed here, a central bank is best viewed as just another financial intermediary, the unique characteristic of which is that it has a monopoly on the issue of some class of liabilities. The Fed creates liabilities out of "thin air" to purchase the assets in its portfolio. A bank creates deposit liabilities out of thin air to purchase the assets in its portfolio. General Motors can create equity claims out of thin air to finance the purchase of new plant and equipment. Further, the fact that the liabilities of the Fed do not represent specific claims to anything in the future is neither here nor there. In private markets, in which Paul puts much trust, we have developed arrangements by which private firms issue claims (stock) which are not specific promises to pay anything specific in the future (dividends are discretionary). Further, private firms make no commitments about their future plans to issue more stock, or to buy back stocks, decisions which will affect the value of stock held by existing shareholders, just as decisions by the Fed affect the value of the existing stock of money outstanding. Nothing mysterious here at all

This is typical Fed bait and switch talk. By calling money "a liability," Williamson is removing it from a special class and arguing a point about Fed money because it falls into a larger class, also. It’s like calling Sports Illustrated cover girl Irina Shayk, a homo sapien. Well, yeah, she is a homos sapien, but being a homo sapien is not sufficient to get you on the Swim Suit issue cover of SI. Or maybe Williamson thinks this is going to happen.

Paper money as issued by the Fed can be, I guess, considered a liability, given their crazed Fed bookkeeping (which Ron Paul wants to audit). But the essence of money is that it is a medium of exchange. Gold, for example, has been used during various periods as money, but it is certainly not a liability. Debt issued by General Motors is a liability of GM, but it is not a medium of exchange. By confusing all these classes, of liabilities and mediums of exchange, it truly is worse than Williamson arguing that homo sapien is the only requirement to get on the cover of SI. But judging from his "powerful people" rant, I would not be surprised if he thinks Bernanke should be on the cover of SI.

Next, Williamson goes into a bizarre calculation of the impact of inflation, without once mentioning prices! Nothing about the price of food, energy or, even the iPad2. Don’t spend too much time on this crazed paragraph, but just know he reaches a conclusion on inflation based on this thinking:

Now, Paul seems very focused on inflation, and the resources extracted from the private sector by way of the inflation tax. It would help here to do some back-of-the-envelope calculations to get an idea of the magnitude of resource extraction. From fourth-quarter 2010 NIPA numbers, GDP was about $14.9 trillion, and total expenditures (by all levels of government) were about $3 trillion, at annual rates (seasonally adjusted), so the tyrant was extracting about 20.1% of GDP (this is all levels of government). Now, inflation has been hovering around 1% per year recently, but suppose it were 2%, which is the Fed’s stated inflation target (not officially, but Bernanke says as much in public). What is seignorageNIPA numbers, GDP was about $14.9 trillion, and total expenditures (by all levels of government) were about $3 trillion, at annual rates (seasonally adjusted), so the tyrant was extracting about 20.1% of GDP (this is all levels of government). Now, inflation has been hovering around 1% per year recently, but suppose it were 2%, which is the Fed’s stated inflation target (not officially, but Bernanke says as much in public). What is seignorage, i.e. the implicit revenue the government collects, through the Fed, from the inflation tax? To calculate this, we need to know what the tax base is. Let’s think of the current stock of reserves as essentially T-bills, which the Fed plans to retire in good time (to take it at its word). Then, the remainder of outstanding Fed liabilities is essentially currency (which certainly corresponds to Paul’s language) which is just short of $1 trillion, so let’s call it $1 trillion just for argument’s sake. Then, with 2% inflation, the revenue from the inflation tax is about $20 billion per year, or 0.7% of government spending, or 0.14% of GDP. Small potatoes, and certainly not enough to justify an armed mob outside the Fed in Washington screaming "end the fed," as Paul seems to envision.

No not small potatoes, high priced potatoes!

As Lew Rockwell pointed out just today:

Not Hyperinflation Yet

But the 3.9% increase in food prices last month  the most since Nixon  is an alarming indicator.

Yet, in Williamson’s mind, and his equations, there is no problem. He ignores what people have to pay for food at the grocery store or for gasoline. As long as his equations tell him, inflation is under the Fed "target," there is nothing to worry about:

…with 2% inflation, the revenue from the inflation tax is about $20 billion per year, or 0.7% of government spending, or 0.14% of GDP. Small potatoes, and certainly not enough to justify an armed mob outside the Fed in Washington screaming "end the fed," as Paul seems to envision.

He then finally admits what the Fed is about, secretive taxation, but of course this secretive, underhanded tax, is superior in his mind to the "primitive" concept of honest, upfront taxation. I kid you not:

There is then a whole branch of economics  public finance  that deals with the issue of how those contributions can and should be made, and the consequences of alternative means of resource extraction for the government. In primitive economies, where the costs of collecting taxes are high and financial markets undeveloped, it can be economically efficient for the government to generate much of its revenue with the inflation tax. In modern economies, we think not.

He then bizarrely tells us that the Fed isn’t doing any significant inflation taxation:

We recognize that inflation is costly, and modern disciplined central banks keep inflation rates low.

He says this despite the trillion in assets that the Fed has bought since the crisis and the continued buying of assets (now Treasury securities via QE2). A lot has ended up as excess reserves not in the system, but the increase in prices to date makes one shudder, if like a Japanese nuclear reactor, significant amounts of funds start to leak from excess reserves into the system.

Read the rest of the article

2011 Economic Policy Journal

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