THE BEAR'S LAIR St Januarius' blood
By Martin Hutchinson
It being January, I am drawn irresistibly to the 19th-century British prime
minister Benjamin Disraeli's only significant contribution to monetary policy
thought, his comparison of a particular step to the supposed Naples miracle of
the liquefaction of St Januarius' blood. His comparison, far-fetched though it
seems, was instructive and it's worth considering whether there are any
equivalent steps that could be taken today.
In a House of Commons speech on August 30, 1848, Disraeli said: "Just at the
moment when unutterable gloom overspreads the population, when nothing but
despair and consternation prevail, the chancellor of the exchequer - I beg
pardon, the Archbishop of Tarento - announces the liquefaction of the blood of
St Januarius, as the chancellor of the exchequer announced that
a wholesome state of the currency had returned: the people resume their gaiety
and cheerfulness; the panic and the pressure disappear; everybody returns to
music and macaroni as in London everybody returned to business, and in both
cases the remedy is equally efficacious, and equally a hoax."
The policy that spurred this rhetorical flourish was that splendid 19th-century
trick by which the authorities staved off liquidity crises: suspension of the
1844 Bank Charter Act. That act had modified the rigors of a pure gold standard
by allowing the Bank of England (BoE) to issue bank notes, but had limited the
issue to a maximum of 14 million pounds. Suspension of the act allowed the BoE
to issue more notes; however, on the occasion concerned, the BoE had not needed
to do so as its ability to issue more notes had itself been sufficient to quiet
the markets and relieve the crisis. Thus a policy that had no tangible economic
effect - that indeed led to no tangible economic action - had nevertheless
resolved the crisis and produced beneficial results. Hence Disraeli's
comparison to the supposed miracle by which St Januarius' blood was liquefied.
The profile of a policy that resembles the famous liquefaction is thus
established. It must be a policy of minimal direct economic effect, which yet
changes market expectations to such a degree that a substantial objective is
achieved. The 1844 Bank Charter Act was in this respect a clever mechanism; it
provided a cap on note issuance in normal times, thus preventing the money
supply from indefinitely expanding and causing inflation, while at the same
time allowing a safety valve to be opened in times of genuine crisis (to use a
steam-age analogy that its drafters would have understood). Whether the
existence of the safety valve had pernicious long-term effects can be argued -
certainly the British banking system became more prone to bailouts over the
century, as was to be demonstrated in 1890 - but the policy lasted 70 years,
from 1844, before World War I destroyed it, in itself not bad going.
The Christmas Eve decision by the US Treasury to extend unlimited support to
mortgage guarantors Fannie Mae and Freddie Mac was such a policy, albeit one
pointed in a pernicious direction. In reality, it makes very little difference;
Fannie and Freddie have such massive political support that no kind of
devastation in their home mortgage operations would cause the Barack Obama
administration to abandon them. However, the unlimited support line from the
Treasury allows them to extend their pernicious operations aggressively, thus
diverting yet more US capital into the wasteful housing sector, and increasing
the contingent liability on taxpayers still further.
Come the November midterm elections, the Democrats will be able to claim that
house prices have recovered substantially on their watch. However, a market
that is propped up artificially in this way has a tendency to extract its
revenge by requiring still larger and larger subsidies in order to avoid
collapsing to its true equilibrium level, perhaps still 15% below current
levels. Thus the cost to taxpayers, homeowners who buy houses in 2010 and the
US economy in general from this particular "miracle" of Treasury sleight of
hand will be substantial.
Turning in the opposite direction, to an action of no direct economic
consequence that could cause a genuinely useful miracle, we can consider the
effect of a modest increase in the federal funds target rate, perhaps to a
trading range of 0.25% to 0.50% from its current 0% to 0.25%.
This would have no immediate economic effect. With inflation already running at
2% to 3% and heading higher, short-term rates would remain heavily negative, so
monetary policy would remain hugely "stimulative" as Federal Reserve chairman
Ben Bernanke and the political class want it.
However, such a move would have a considerable effect on commodity and energy
markets. At present, the main near-term threat to continuing economic recovery
arises from these markets, in which prices are continuing to rise and may at
some point get to levels that threaten recovery, by draining purchasing power
out of commodity-using Western economies and/or produce a confidence-sapping
acceleration of inflation.
With interest rates near zero, speculation by hedge funds and other money pools
on commodity price rises appears a risk-free proposition, as such speculation
can be financed at negative real interest rates. Only when it seems likely that
interest rates will rise to positive real levels will speculators back off the
commodity markets. A 0.25% rise in the Fed's target range would create doubt in
the mind of commodity investors, thereby slowing the inexorable rise in
commodity prices and delaying the moment at which policymakers have to get
serious about incipient inflation.
Such a rise is a perfect "St Januarius' blood" move therefore. It has no
significant direct economic effect but is nevertheless highly efficacious in
achieving policymakers' goals. But even with this incentive, I doubt that
Bernanke will do it.
Another way in which policymakers can have a "St Januarius' blood" effect is by
ostentatiously choosing an economically sensible policy that blocks the
possibility of economically foolish ones. France is doing this with its carbon
tax. While the version of the tax that is being debated has too many loopholes,
a carbon tax at a moderate rate has two beneficial effects: it helps to reduce
the budget deficit, which in France as in many other countries has grown
dangerously large, and it staves off the possibility of the
bureaucracy-creating economy-destroying monstrosity of a cap-and-trade system
of emission controls such as proposed by the US Waxman-Markey bill.
Any time the private sector can be left to make its own adjustments, with the
addition of a moderate tax that steers it in the politically preferred
direction, a huge bullet has been dodged in the economy-sapping additional
costs that are normally imposed by state control.
The United States could have a similar benign effect by agreeing to raise the
eligibility age for Social Security and Medicare entitlement by one month each
year from 2026, the year in which the Social Security retirement age reaches
67. Such a change would have no direct economic effect at all for the next 16
years but it would at a stroke eliminate the long-term deficit in the Social
Security system and greatly reduce that in the Medicare system.
Further reductions in the Medicare system's deficit certainly require a year or
two to allow the whole healthcare question to be depoliticized after 2009's
battles. Then, some cost-saving measures such as limiting damage awards for
medical malpractice are themselves highly political.
However, there is one counterintuitive measure that could be taken which would
hugely reduce costs in the system overall even though at first sight it would
increase federal funding for healthcare. That would be for the federal
government to fund properly the mandate it imposed on hospitals in 1986 to
treat indigent patients in emergency rooms, without regard to their ability to
pay.
If the federal government reimbursed the costs of this mandate, hospitals would
no longer have to load the losses onto the charges for insurance-covered
patients or the even higher charges on individuals, nor would they have to
employ a large staff chasing deadbeats. Since the unfunded cost of emergency
room treatment is estimated at US$80 billion annually, transferring that burden
to government would save two or three times that amount from the costs to
insurance companies and individuals of medical treatment, probably saving 1% of
gross domestic product from healthcare costs by that reform alone.
Few are aware of this unfunded mandate imposed on hospitals, which appears to
be of no political salience. Moreover, its correction would be close to
budget-neutral if costed properly because the federal government already pays
medical costs for such a high proportion of the populace. However, its economic
effect would be large and benign. It thus qualifies as a "St Januarius' blood"
policy. It is also ethically correct; the government should not be imposing
quasi-charitable mandates on businesses without paying for them.
Policies that are "equally efficacious, and equally a hoax" are the ones
policymakers should be looking for. They are easy to impose because they appear
to have few wider implications, economic or political. Yet their real-world
effect is substantial. Of course, as in the case of housing finance, it helps
if politicians don't pick the worst such policies, which lead in an
economically damaging direction. But nevertheless they remain very useful tools
when you can find them.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-10 David W Tice & Associates.)
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