38 BARRON’S July22,2019
CURRENTYIELD n ByJamesGrant
The Big Flaw in Ph.D-conomics
Centralbankersbasetheirratepoliciesontheirforecasts.Whatcouldgowrong?
THE PH.D. STANDARD OF
monetary management
was the topic on the
agenda at the July 15
panel at the American
Enterprise Institute in
Washington. Discretion-
ary central-bank policy conducted by for-
mer tenured economics faculty, or by peo-
ple imbued with the doctrines of those
learnedpeople,isthesysteminplacetoday.
We discussants pulled at our chins: Is the
system any good at all?
It’s a timely, down-to-earth question.
FederalReserveChairmanJeromePowell,
thoughalawyerbytrade,doesbusinessin
abuildinginfusedwiththedoctrinesofthe
hundreds of doctors of economics on the
FederalReserveSystem’sgenerouspayroll.
To a bond buyer, three of these proto-
cols hold special significance.
No. 1, the value of money ought not to
befixed,butfluctuateintheserviceofen-
lightened macroeconomic policy.
No. 2, “price stability” means a rate of
riseofarounda2%perannuminthecon-
sumerpriceindex.Toolittleinflationistan-
tamount to deflation.
No.3,interestratesarenotpricestobe
discovered,butdialstobeset.Youturnthe
knobs to advance the cause of macroeco-
nomic stabilization.
It follows that the value of a bond de-
pends on the skill of the central bankers.
Allan Sproul, longtime president of the
Federal Reserve Bank of New York,
enunciated this doctrine 70 years ago. Fi-
nancial discipline is essential, he said,
“but it should be the discipline of compe-
tent and responsible men, not the auto-
matic discipline of a harsh and perverse
mechanism,” that mechanism being the
gold standard.
Naturally, to turn the policy dials cor-
rectly,onemustforecastaccurately,butwho
candothatconsistently?Ratesofinflation,
employment, and growth go their merry
way,asiffortheexactpurposeofconfound-
ing economists at the control panel.
Still, the central bankers forecast, and
onthoseforecaststheybasetheirpolicy.In
theextremecaseoftheEuropeanCentral
Bank,thepredictiveNorthStaristhefive-
yearforwardinflationrate,i.e.,theimputed
rateofinflationforthefiveyearsstarting
in2024.Aftermentioningthatdistantdate,
apanelistdrylyasked,“Isitgoingtorain
a week from Thursday?”
Ben Bernanke, a Ph.D. in economics
fromtheMassachusettsInstituteofTech-
nology, put in a word for the soothsaying
guildin2010:“Iwouldsaythattherecent
financialcrisiswasmoreofafailureofeco-
nomic engineering and economic manage-
ment than of economic science.”
“Adherents of the Bernanke doctrine
are,infact,disadvantagedincomparisonto
the average Charles Schwab customer,” a
panelist remarked. “Practitioners whom
Mr.Markethastakentoschoolknowbet-
ter than to think they can predict the fu-
ture.RareisthePh.D.withpracticalexpe-
rience in the field of margin calls, client
redemptions,orunsightlydrawdowns.Itis
easiertobelievethatonecanforecastcom-
ingeventswhenonehasn’tbeenpunished
for trying.”
Marriner Eccles, the Fed chairman
(1934-48) whose name graces the central
bank’s Washington headquarters, never
completed the 12th grade. An heir to a
family fortune, but also a successful com-
mercial banker in his own right, Eccles
made his share of mistakes. Still, he had
the courage to stand up to a president—
for him, it was Harry Truman—and to
make his case in plain English. The tenor
of his opposition to post-World War II fi-
nancial policy is conveyed in a headline
over a 1947 Wall Street Journal dispatch:
“Eccles Sees Economic Collapse Unless
Nation Checks Inflation.”
Benjamin Strong, famed president of
theFederalReserveBankofNewYorkin
the1920s,didfinishhighschoolthoughhe
neverattendedcollege.Hewasfunctionally
theCEOofBankersTrustin1913whenhe
passed private judgment on the pending
FederalReserveAct:“Thisisaprovisional
returntotheheresiesofGreenbackismand
fiatmoney,”hesaidbeforeevidentlychang-
ing his mind. Never mind the word “her-
esy”; Strong was right the first time. Be-
fore very long, the old gold dollar became
that very greenback.
William McChesney Martin, the lon-
gest-serving Fed chairman (1951-70),
studied English and classics at Yale be-
fore sampling some postgraduate econom-
ics courses at Columbia University. Per-
haps the latter experience explains his
reluctance to bring professional econo-
mists into monetary councils during his
time at the Fed. Martin, who once had a
thought of entering the Presbyterian
ministry, famously said that the Fed’s job
was to “take away the punch bowl, just as
the party gets going.”
A little less famously, he also said, “in-
terest rates are prices which perform vi-
tal economic functions and they should be
responsive to basic supply and demand.”
In so declaring, Martin might have been
thinking of Sproul’s contention that the
Fed should be active in manipulating in-
terest rates across the length of the yield
curve. No Ph.D. was Sproul, though he
anticipated today’s monetary-policy type.
Martin stood for price discovery and the
financial discipline that seems to have
disappeared into the muggy Washington
air.
Ecles, Strong, and Martin shared one
thing besides a hole in their educational
resumes. They came of age when the dol-
lar was defined in law as a weight of
gold.
This convention today’s economists al-
mostuniversallyderide.Butwhateverthe
meritsordemeritsofyesteryear’sobjective
dollar,today’sisasubjectiveone—itsvalue,
like the level of interest rates and the
shape of the yield curve, is the central
bank’stodetermine,or,ifnottodetermine,
heavily to influence.
With one exception, the AEI panelists
weremoreorlessatpeacewiththeworld
asitis—notwitheverydetail,butwiththe
natureofmodernmoney,andwithmany,if
not all, of the techniques of 21st century
monetary management.
Thedissenter,yourcolumnist,willsub-
mit his ideas to the not-so-tender mercies
ofthemarketplace.Whichwillitbe,fellow
investors,governmentbondspricedtode-
liveranegativerealyield(andintrillionsof
dollars worth of cases, a negative nominal
yield)?Orgold,thelegacymonetarymetal,
yielding nothing but providing a handy
negativebetontheprinciplesandpractice
of busybody central banking?
JAMESGRANT,founderandeditorofGrant’sIn-
terestRateObserver.istheauthorofBagehot:
TheLifeandTimesoftheGreatestVictorian,to
be published this week.
Joel Arbaje (Illustration); Shay Moradi (Source)