Inflation Targeting Fails: Thailand’s Central Bank Chairman Admits

The Chairman of the central bank of Thailand says that inflation targeting has no longer been effective.

From Businessweek/Bloomberg,

Bank of Thailand Chairman Virabongsa Ramangkura comments on inflation targeting. He made the remarks during a speech late yesterday in Bangkok.

Thailand’s central bank has used inflation targets since 2000 and aims to keep core inflation, which excludes fresh food and fuel prices, between 0.5 percent and 3 percent.

“Central banks should change their ideas. Inflation targeting is no longer effective because inflation has been globalized. The world is more open and we are a member of the World Trade Organization. Commodity prices are driven by global supply and demand, not policy of a particular country.

‘‘So monetary policy shouldn’t be used to deal with inflation because we can’t do anything. Monetary policy should be used to support economic growth and reduce unemployment, which we call inclusive growth.”

“The source of instability for emerging countries is foreign exchange, not inflation. The stability of the foreign exchange rate depends on capital movements. If our interest rates are higher than dollar rates, that will open a loophole for attackers. This creates financial instability. So, monetary policy should take care of this, not inflation.”

Virabongsa says his views run counter to those of Governor Prasarn Trairatvorakul.

Ineffective, here, represents euphemism for failure

In truth, central bank inflation targeting has failed and will continue to fail, not because of asymmetric levels of “foreign exchange rates that depends on capital movements”—which accounts for a verbal sleight of hand in order to shift the blame to the capital markets—but rather from the following:

1. Central banks don’t know where and how their interventions—via money printing—will end up.

2. Central banks cannot ascertain where exactly is the so-called invisible “equilibrium price level”.

3. Because they don’t know both 1 and 2, central bank inflationism leads to excesses which produces boom-bust cycles and raises the risks of intractable (consumer price) inflation

4. Most importantly, inflationism has always been about promoting the political interests of the political authorities and their cronies.

And political goals principally conflicts with economic reality. Example: repeated bailouts of crony firms end up consuming the capital of the economy. Long term has been sacrificed for the short term. Productive capital wasted on unproductive politically supported undertakings.

Yet bailouts, has been, and will be justified through the camouflage of economic technical gobbledygook called “aggregate demand”.

To quote economic professor Antony P. Mueller,

Inasmuch as central banks dominate the discourse about monetary policy, there is almost no debate going on about the thesis that inflation targeting is not only defective in guaranteeing monetary stability but that it also provided the conditions for the current financial crisis to happen.

The episode that was praised as the great moderation was a great delusion, which has become the nightmare of a long stagnation.

There is a vital need to establish a sound monetary system. Its consequence would be moderate deflation and the avoidance of extreme booms and busts.

The main barrier against sound money is neither intellectual nor practical but political. The resistance comes from the public sector because the chief casualty of an institutional change to sound money would be the modern inflated government along with its warmongers, debt pushers, and all the rest of the spin doctors of deceitful promises who form part of this kingdom.

Yes inflationism or “something from nothing” policies via central banks has essentially been grounded on the politics of the Santa Claus principle.

So whether viewed from the knowledge problem of centralized institutions or from political dimensions or incentives guiding the political authorities, inflation targeting have been destined to fail.

Euro: Geopolitics Over Economics

Austrian economist Dr. Antony Mueller writes, (bold highlights mine)

“the fact that the euro is more a political than an economic project. Even more: the euro is an instrument to (re)gain geopolitical power for the Europeans. In other words: the euro is an imperial tool. In this respect bad economics is a given. The euro does have moral hazard effects...Yet the main point is that the euro project itself is hazardous game. Bad economics would no longer matter if the gamble will succeed. Current losses would be recouped a thousandfold just if oil were traded in euros or partly in euros. As of now it is already a fact that no far-reaching decision concerning the international monetary order can be taken against the will of the leaders of the eurozone. On a net basis, and even with the costs of the current sovereign debt crisis included, the euro has been beneficial for the whole region and beyond.”

Global foreign currency reserve from wikipedia

The time consistency dilemma of money that has been engineered for geopolitical incentives has limits. True, the euro has been gaining market share at the expense of the US dollar in terms of foreign currency reserves but the gains will always be relative.

Yet any political environment that thrives under bad economics will have interim benefits but eventually suffer from the recoil of the imbalances borne out of such bad policies. The euro or the yen or the yuan or the Philippine peso will not escape this basic economic laws at work. There is no free lunch.

To add, the perspective of politics over economics has been the path dependent policy approach employed by current crop of policymakers globally. In other words, interpreting actions by policymakers to address economic problems may not entirely be valid. Economics may just be a front or a cover for other ulterior political motivations that drives the decision making process of the political authorities as the Euro.

To quote economist Thomas Sowell,

Economists are often asked to predict what the economy is going to do. But economic predictions require predicting what politicians are going to do-- and nothing is more unpredictable.

Trigger To The Inflation Time Bomb

Will the trigger to the inflation time bomb be setoff soon?

According to Dr. Antony Mueller

Look at these two curves as if they were electrical wire all it takes a little twiggle of the money multiplier to surge and the bomb will explode. While it would be hard and enduring task for the central bank to reduce the monetary base, it only takes a whiff for expectations that determine the multiplier to shoot up. The bomb that will be ignited has already a name. It's name is "hyperinflation".

Mainstream have long been fixated about deflation.

But like Waiting for Godot, this has not occurred yet, and will unlikely happen unless the Fed accedes to the environment of shrinking liquidity at the risk of the implosion of the US banking system.

Ironically, this would defeat all their trillions of rescue efforts to the politically privileged industry. (As we long have been saying---bailouts were directed NOT primarily to save the economy but the political-economic class that depended on the benefits of seignorage from the US dollar standard.)

Also as we have long spelled out, the US yield curve cycle has a 2-3 year lag period from which we should expect it to generate “traction” by the last quarter of 2010.

And given the recent marked improvements in the credit markets of the US as shown below...

From St. Louis Federal Reserve...

From Northern Trust...

Not only is the yield curve cycle being validated, as US banks become more “open” to issue loans rather than seek safety in securities, but this also heightens the risk of the proverbial "pulling of the trigger" to the inflation time bomb.

3 Decades of Boom-Bust Cycles From The Greenspan Put

Professor Antony Mueller, in his blog, enumerates the litany of events which had been supported by the "Greenspan Put" or the monetary policy of lowering of interest rates to provide for liquidity injections in order to support asset markets.

This became a permanent feature in today's financial world and had been deeply embedded to the public's psyche almost similar to the conditioning effects of Pavlov's Dogs.

Unfortunately, unsustainable booms eventually transitions into nasty busts.

From Professor Mueller:

Bailout economics – three decades of monetary excesses

1987 Stock market crash
1988-90 Savings and Loan crisis
1990 Stock market “mini-crash”
1990-91 Gulf War I
1990-91 US mini-recession
1994 Mexican peso crisis
1997 Asian financial crisis
1998 Russian debt crisis
1998 Long-term Capital Management collapse
1999 Y2K liquidity crisis
2000 NASDAQ collapse (dot.com bubble)
2001 US recession
2001 9/11 terrorist attacks
2003 Gulf War II
2003-2004 Deflation scare
2005 Housing froth
2007 Beginning of housing crash
2007 Financial market “freeze”
2008 Stock market crash
2008 Year of the mega bailouts
2009 Financial crisis turns into economic crisis

In addition to Professor Mueller, the chart below is an illustration of the above (I forgot the source of this-my apologies)

And the boom bust cycle as aptly described by Roger Garrison is a constant of the Austrian Business Cycle Theory. Mr. Garrison explains (all highlights mine),

``The Austrian theory is not a theory of recessions per se; it is a theory of the unsustainable boom. As such, it has a much stronger link to the underlying microeconomics than does much of today's mainstream theorizing. The Austrians focus broadly on credit markets and ask what happens when the price of credit, i.e., the interest rate, is held below its market-clearing level. If interest rates were held too low by legislation (interest-rate caps), there would follow an immediate credit crunch. This "if-then" proposition is a direct analogue to the proposition that rent control causes a housing shortage and, more generally, that price ceilings cause quantities demanded to exceed quantities supplied.

``But what if the central bank papers over the shortage with newly created money? Would this way of bridging the gap between credit supplied and credit demanded transform the would-be credit crunch into sustainable economic growth? Hardly. It would simply insert a time delay between the "if" and the "then." In effect, the credit crunch is transformed into a boom and then a bust. The extent of the resource misallocations during the boom have a direct bearing on one aspect of the downturn. The necessary reallocations are roughly proportional to the prior misallocations. It is in this context that we can say, "the bigger the boom, the bigger the bust." But for both theoretical reasons and historical reasons, busts can and often do dwarf the preceding boom."