Bloomberg on the ECB vs. the Fed

Bloomberg is frequently among the best in business journalism, but this July 17 article by columnist Mark Gilbert, entitled "Keynes Arouses Fed as ECB Looks for Monetary Exit," misses the mark on a few critical points.

Essentially, Gilbert lays out a framework for understanding monetary policy options for the European Union and the United States:

The battle lines are being drawn. On the Keynesian side of the equation is the Fed (with an acknowledgment that these are strange days indeed when the U.S. seems more left-leaning than mainland Europe), under a new president who has no qualms about spending public money to either prop up or appropriate private companies, much as John Maynard Keynes might have advocated...On the other is the ECB, sired as it was by a Bundesbank inculcated with memories of German hyperinflation in the 1920s, and much more in tune with Milton Friedman’s warnings that inflation is always and everywhere a monetary phenomenon.

In short, the Americans are tempted to be soft on inflation (cut or keep rates low) and the Europeans are tempted to be hard on inflation (raise rates). Fair enough, but the Weimar Republic's hyperinflation has little to do with it. Some thoughts:

1. The Federal Reserve is an established institution with nearly a century of political capital to shield it from second guessing. The European Central Bank, conversely, is a new institution and none of the major EU nations are comfortable allowing it to manage policy on a supranational basis. The result is an ECB that must work much harder to prove to the market that it is independent, while the Fed finds it easier to shrug off congressional grandstanding for easy money.
2. Weimar inflation of the 1920's, while undoubtedly an important historical example of what can happen, occurred before most people alive today were born. The near collapse of the German mark after World war II, plus the endless inflationary decades from the Latin Europeans into the 1980’s, are within the memory of most European policy makers and many European voters.
3. European's structural rigidites -- labor markets, enormous government sector, high levels of regulation, etc. -- mean the upside to growth is lower than in the US. This, again, favors the hard money position.
4. Europe shows a much more balanced trade picture than the US, so there is less of a push by the world to get its consumers spending again. This is a pressure at the margin, but a serious one. To an unhealthy extent, the world economy turns on the US as consumer of last resort.

From the Bloomberg piece:

“We’re not going to repeat the classic mistake that the U.S. made in the 1930s and that governments around the world have made in financial crises, by at the first sign of hope putting the brakes on prematurely,” U.S. Treasury Secretary Timothy Geithner said this week...Those are scary words for the growing crowd who expect money supply -- that economic relic we all used to scrutinize in the bygone years before central-bank minutes and inflation targeting -- to come back into fashion with a vengeance.

This misses a critical point. The US monetized, directly or indirectly, a great deal more wealth via credit lines on real estate and such. The asset wealth destruction of the past three years more directly cuts our money supply than Europe's or Asia's. So, even if one is a monetarist the question becomes: what money supply definition do you use? It is commonly agreed a great deal of thepseudo-boom in the US was fueled by using housing and stock market wealth as ATM machines. This vanished. So US money supply may be down far more than most figures show. In reverse, a fair portion of the US growth of national debt goes off to East Asian treasuries, where it is for now sequestered and out of the money supply of all concerned.

Granted, this is not a workable long term situation, but it is a reasonable description of current and near future reality. The US imports based on magic money with no concept by the East Asians that the US is ever to run a surplus to repay the "debt." This is destabilizing in many ways, but in monetarist terms it is simply outside the Milton Friedmanite definitions of money.

One last point. From the piece:

It may mean, though, that investors have a clear choice. Buy dollars, on the basis that preemptive ECB action will strangle the European economy and you don’t want to own the currency of a region in trouble. Or buy euros, on the grounds that higher ECB rates will deliver a higher return at a time when the U.S. is willing to debase its currency and risk blowing bubbles. Either way, sitting on the fence waiting for Goldilocks doesn’t seem like an option.

The currency bet is a no-brainer. In the short term, it is always better to bet interest rates over fundamentals. There are massive other factors at work, but fundamentals play little real role in currencies these days.