Tuesday, July 12, 2011

Central Banks and Jobs Creation (Unemployment): Central banks don't matter much

Central banks of the world always obsess about economic growth, job creation etc. They mistakenly believe that they can effect job creation by changing the interest rates, increasing M1 and M2 money supply, and all kinds of economic data jargon (in general, if people use jargon and complicated words, it is most likely that they are trying to fool you. I am very wary of "complicated truths" and jargon-laded commentaries, especially in Economics, where 90% of Economists are parrots reading out loud whatever crap they were taught when they got their PhDs ). Not only the banking and financial guys start believing in all these powers they have, they managed to convince astute businessmen, governments, etc. that they indeed have these powers. It is highly doubtful that central banks can do anything to create jobs, influence interest rates, the economy, etc.

Money is just a unit of measure

Money is a way to exchange goods. It is a unit of measure, a very convenient unit of measure, but nothing more than that. It is the standardized unit by which people compare and exchange whatever they produce.  When Google millionaires spend their money on a vacation in Hawai or going to a fancy restaurant; they really exchange their product, the search engine, with what a vacation rental company in Hawai offers them, or what the fancy restaurant company offers them. That is the real exchange going on between people; money is a convenient way to quantify these exchanges, and compare the relative values of these exchanges.

That you can somehow magically change people's productive powers, what products they make, by changing the units of measure, sounds bizarre to me. If they resort to low interest rates, there's no reason to believe that people will rush out tomorrow to pay higher prices for the same products. People are not that stupid, you know..they always are pushing to lower prices, not paying higher prices.

Just by changing a unit of measure and exchange you can't make people produce things which other people  will find useful and will exchange their products for. i.e. you can't generate employment by playing around with interest rates, etc.

Instead of dollars and yuans, if we were to decide that sea shells were a unit of exchange, will you believe the sea shell makers and suppliers when they tell you that they can increase everyone's ability to produce the stuff they produce by changing the amount of sea shells which are used to circulate their products? You obviously wouldn't--then why would you believe a central bank can?

Do you think that a poor nation in Africa with unemployment of 40% can become suddenly rich  or lower their unemployment by an intelligent banking system alone-that a central bank of that nation, playing with interest rates, money supply, etc. can reduce unemployment? If money and interest rates don't have a major  role to play there, why would you think that in a developed economy like the US or Japan or EU, you could suddenly increase employment by playing with interest rates?

The bankers obviously believe that they are the most important part of the system. But a farmer and a computer-maker has an equal right to claim that. No one sector of the economy can single-handedly improve the productive powers of other sectors. Not the least a sector which like sitting on their asses and watching noise like inflation and GDP growth to decide interest rates, etc.

Don't expect the central banks or governments to help the country's employment numbers. Capitalists create employment, not people who run the currency of a country. They are claiming to have powers which they don't really have.

Interest rates are set by the market, not by central banks

Interest rates are set by the market-a central bank doesn't set them. This was explained well by Smith. The central banks are a bunch of people with water guns, they like to believe that they are the ones in control, whereas in reality they have little to no effect on the economy. Economic activity is far more that interest rates and money and the banking system. In reality, the capital involved in buying and selling money, which is what the whole financial sector is, is taken away from the useful capital of society. Money, as Smith said, is the highway to assist in the exchange of goods (and services). Any capital going into building the highway or making it run more smoothly is a loss of capital from the other parts which produce goods and services. The financial sector of the S&P500 is about 10% of the index; and that should be excluded from economic activity. Same goes for GDP and other measurements; the earnings etc. of financial companies should be excluded from those measurements. Money is just in instrument to make the trading of goods and services easier-it in itself has no value. Central banks, financial companies, etc. are nothing more than aiders to economic activity.

Central banks, banks and the financial system in reality follows the market in setting rates (from Adam Smith). They can't set the price at which people borrow-but it does make sense for them to follow the market rates. When rates are low, as they are currently (2016), it means that the demand for loans in the market is low-and that's why the interbank rates, fed funds rate. etc. are low. Not  the other way around. When the market has high interest rates-the Fed fund rates, etc. will all go up together with it, as they should.

Economists are often times seen talking about interest rates and monetary policy. I don't know how that came about, or when; but they have missed the most essential lesson of Smith-that money is just a means to facilitate trade, nothing else. Fussing over 1% or 0.25% interest rate increase or decreases is a joke.

The jobless rate in the US, a silly number

These is a report published every month by BLS which is taken as the holy grail apparently for the Federal reserve to measure unemployment rate. The report shows that 95 million Americans above the age of 15 are unemployed at any point in time (in the month) and not even looking for a job. In the around 150 million people who are unemployed at any time, there are another 95 million who are not (it is called Participation rate)! This 95 million figure keeps changing too, and they publish that-it is 100 million sometimes, then 92 million, etc. etc. These are people taking temporary rest, out of job, working part time, traveling around, retiring, etc. etc. There is no reason to assume that there is a stable rate for this-i.e. Participation rate is not a constant, just another number thrown at the giant wall of data, and seeing what sticks. Most of the job report number fluctuations can be accounted for the flux between people who do not want to work for whatever reason, not because of interest rates, M2 money supply, etc. as the Federal Reserve wants you to believe. But the report ignores these details completely, because it has to come up with a nice number of around 5%...and obliges us with that. A large number of people do not want to have full time jobs in the US, and that is ignored by statistics experts like the BLS. The Fed in turn takes these numbers, and calling it data, talks about reducing it etc. Here's an article explaining the shortcomings of these report.  and another one here. My point-the labor statistics are noise, joblessness is noise, and constantly changing, people don't work in a full time job for 5 years, then go back to work full time for 8 years, then go and travel and do nothing..all these things are not considered at all in the data! Garbage data put into a model of economy...

The biggest way to realize the bullshit data of the jobs report and unemployment rate is to think about the standard deviation of these numbers over time. A jobless rate of 2% to 10% is completely normal in my mind, it is the nature of things, and can't be attributed to one cause or another-knowing fully well that 37% of the adults call themselves unemployed at a particular time and we are okay with that!

Another big problem with the job reports is that it relies on surveys and then extrapolates. People lie in surveys, and there is no  stable underlying distribution to think that surveys can be extrapolated. They may be statistically invalid procedures...two big ones this year (2016) when surveys got it wrong were that Britons wanted a Brexit and Americans wanted Trump to be president-survey data indicated that these things won't happen, but they did. This is a general problem with all surveys, as I have convered here.


GDP measurements are imperfect, and sometimes woefully inaccurate

From GDP measurements, which is another "data" published by a lot of so called economists who don't get the main part of economics, it seems that the Japanese GDP has been stuck at the same value since 1990 (to 2016, when I am writing this part of this post). According to GDP publishers and people who believe in that number, Japan, a developed nation of 120 million people, has not advanced at all on the last 26 years! Instead of accepting that maybe the GDP data is not capturing the progress of that wonderful country, they keep insisting that Japan really has gone nowhere in 26 years. I rest my case.

Interest rates, unemployment rate, GDP etc. are some very imperfect numbers, and they must not affect public policy too much. These are full of wrong information, as the Japan example shows. Another example is Venezuela; everything in South America knows that Venezuela is in a lot of trouble right now, people are forming lines to buy bread and milk, supermarkets, are empty etc. but the GDP per capita number of Venezuela is still published as a number above USD 10K. The country is in a lot of trouble, and anyone who follows news from Venezuela knows this, except the finance and economics types, who believe in some strange number and put Venezuela ahead of Peru and Colombia. A very large number of Venzuelans are immigrating every month to neighboring nations; and can testify that things are quite bad out there. Something like this is not reflected in the GDP per capital data at all.

Prudent borrowers and lenders decide the real rate of interest

Interest rates are decided by the market-you pay more to borrow if your profits (of stock) are higher. Just because a central bank has low rates (as in Japan or US right now) does not mean that people will borrow, or that the banks will like to make loans. Banks themselves have no interest in losing money, and even if interest rates of the dollars or yens they get from the respective central banks are low (if the central bank is willing to put up with easy balance sheets of the private banks), if they find the the borrowers are a bunch of irresponsible people (workers, or people who want to borrow for very risky projects) they will not make loans to them-because they will lose their principal. That risk is somehow not considered by the economics and finance folks. A private bank getting a low rate of interest from the central bank is not obligated to loan money. It is in the bank's own interest not to loan money to speculators, lazy people etc. because they will not even pay back the principal advanced to them-forget about the interest charged to them. This is what happened in the 2008 crisis and probably many other crises-the banks loan to projectors who promise fast and amazing returns, the projects don't work out, and not only the projectors go under, but the banks who loan to these projectors also go under. Banks do not manufacture money out of thin air-they are always tied down by the deposits and the payments they are receiving from mortgages, etc. to decide if they can loan more money to other borrowers. If they find that the project is too risky, they will not loan. The ones who do will go under, or lose a part of their loan. The interest rate on the loan is decided by the market-if the people think that they can employ the money usefully, and if they have no problem returning the principal with interest, they will borrow. In general, in any economic transaction ( a transaction not done under duress), the buyers decide the price-the sellers only make offers. Prudent borrowers will not borrow even at low interest rates if they cannot employ capital successfully to make sure that they return the bank the principal and the interest.

I continue where Adam Smith left us in 1776-most money is borrowed by prudent borrowers, and most money is loaned by prudent banks, who, are careful about their own well being, the classic self-interest of Adam Smith. Therefore, speculators and risky borrowers are bad for the banks as much as they are bad for themselves (they will get ruined and will take the bank principal down with it). If the bank is giving loans to the wrong people, regardless of whether the loan is made at high or low interest rates, it will go under itself. The principal itself might not be returned.

Central banks have no influence on inflation rates

Central banks claims of controlling inflation rates are even more questionable. We must always remember what Smith said in WN-the real quantity of goods and products do not change with small changes in the amount of paper money circulating in the country.  Paper money is just a highway to carry things around, to facilitate the exchange of goods and services. It is in itself not consumable, nor of any use.

Normal inflation measurements are very noisy, and most of the massive data taking going on today on inflation with ever changing inflation baskets is nothing but noise. See more about this on this blog post.

Original purpose of creating central banks was to provide a backstop, nothing else

Central banks were formed to prevent massive crises in the banking system. Note that the US Federal Reserve Act is of 1913, and even after that, there was the massive collapse of stocks and the so called Great Depression in 1929. Obviously they couldn't prevent that. More recently, the 2008 crash was not preventable by all the jargon of price stability, interest rate stability and increasing unemployment which the central bank is supposed to provide. What they do provide, is the security when the panic is on and full blowing. They are like firefighters-they do nothing most of the time, but when there is a fire, they will help society. That's how central banks were formed (previously, there were only private banks, who would all go bankrupt together, and the savers would lose their deposit). The FDIC guarantee is an extension of that-to reduce the probability of bank runs and savers losing deposits.

Let's not credit the firefighters for creating the world's tallest buildings and the subway lines. They are there when things go bad; but in reality are an expense when things are going good (They are the put seller on the financial system and savers deposits in the banks).

Everyone likes the guarantee of a central bank that their deposits are insured at least upto $200K or $250K. But beyond that, they can't do much. I know personally someone who still can't get $ 5 million they had with Lehman Brothers in 2008. Let's not give too much credit to the central banks in normal times-they really do nothing in those times. Once again, they are very useful in bad times, providing the market support which is necessary; but beyond that, having monthly meetings to set interest rates, looking at all kinds of noisy data like inflation, GDP, employments numbers etc. is a lot of hogwash. They pretend that they can do something about all these numbers; they can't.

Provide price stability is also in the original Fed Reserve Act of 1913. They readily discard the volatile food and energy prices to come up with a smooth inflation number-they promote price stability by discarding volatile data! Poor people spend a lot of money on food; and discarding food and energy costs is clearly not right. Note also that despite all intentions of price stability, prices of commodities, stock market values and people's savings and investments, real estate etc. crash all  the time. Clearly they are not able to do much. You can always argue that it would be even worse if there was no central bank-and that's a completely valid argument-but in my opinion, you are giving too much weight to what a central bank can do. The central bank is a bank of banks, and all banks can do is transfer money from real savers to real borrowers-they cannot generate loans out of thin air, otherwise their balance sheets reflect it, and they go belly up. This happened in 2008 to many banks. And it has happened to the central bank as a whole in Venezuela-which is clearly bankrupt. Note that cash held in deposits is a liability for the bank, and the assets and interest payments on them must match these deposits-otherwise a bank, including a central bank like of Venezuela right now, is bankrupt (Assets less than liabilities, and not able to pay interest payments). This is the cause of devaluation of their currencies. The shenanigans of a bankrupt central bank don't last very long, just as the shenanigans of a bankrupt company or individual-soon people get a whiff of it and stop doing business with it. Most products in Venezuela are quoted in USD for this reason. Same with Argentina until recently, when Macri got elected and things seem to have stabilized a bit.

Bank of Japan is buying stocks in the Nikkei to "stimulate the economy and get growth back". See article here. They don't give up, do they? Their interest rate policy didnt get them anywhere for the part 20 years, so now they created another model-let's see if buying stocks creates growth and creates jobs. Banks can't do squat! Economic growth is decided by the hard working Japanese, the real capital owners of Japan, not a bank which is just in the business of transferring funds from lenders to borrowers. They will come up with newer and newer theories of tackling inflation, job growth, unemployment, etc...but will not accept that they have no effect over any of these things.

Dicking around with money, whose sole purpose is to help the transaction of goods and services, doesn't do anything to the real value of those goods and services.

Here's what Smith said about operations of banking, and how they help us:
"It is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country. "

See also: On recessions-confusing nominal value with real value of money

Sanjay