Tapering delayed: another historic moment for the FED?

Yesterday evening, Money 2.0 was on the agenda in the Arminius church in Rotterdam. It was an evening in which I briefly outlined some of the major developments and lessons from monetary history to the audience. This coincided with an announcement of the Federal Reserve Board on their monetary policy, that may prove to become a historic case in point.

Balancing the amount of money against economic activity
I explained that history learns us that the amount of money in a society needs to balance the economic activity. The role of central banks is to monitor both and make serious judgment calls as to whether or not contract or expand the so-called monetary base. Expanding too much may lead to high inflation, and a more restrictive approach can lead to deflation. Finding the right balance is thus the essence of monetary policy.

I sketched that each country has in the past experienced a different learning curve in executing monetary policy. These differences help to explain why the German central bank (and the ECB, in its first years of existence) tend to be restrictive and careful not too expand the money base, while the FED appears to lean towards easing the money supply. As if to prove my point, at that very moment, the FED informed the markets that they were delaying their planned contraction of the monetary base until the economy would be seriously better.

Now, let's see where this might be coming from.

Different lessons lead to different central bank styles
First, we will look at the situation in Germany between the two World Wars. Germany had to pay France a huge amount of money as 'repair' payments for the damage done in the war. A sequence of events in 1922 however makes it clear that the Germans will have a hard time paying back their money. And as a part of the conflict between France and Germany, the Germans start printing money, to finance a strike in the industrial area of the Ruhr. The cumulative effect of the developments - see Kindleberger-  was hyperinflation and even the Dutch still recall this (some of us are still holding worthless million mark notes of those days).

Now, let's have a look at the United States at the end of the 19th century. We can see a depression, deflation and a shortage of money. And there is a serious debate as to the use of gold or silver as a standard to base the currency on. This discussion even filters down to a book, the Wizard of Oz, as Hugh Rockoff explains here. In short, the US experience is that you have to be careful not to have a shortage of money.

As both memories linger on in the collective minds, we can thus see that the German central banking approach is not to ever encounter high inflation again. They tend to be on the careful side and tried their utmost to instill this sense of discpline in the European Central Bank. Meanwhile, the FED is making sure not to ever encounter a shortage of money again, so are expanding their money base more easily.

Delayed tapering: a historic moment ?  
When the FED yesterday announced that they were not yet going to contract the money base, this came as a surprise to the market. Earlier this year, Bernanke had explained that the FED would slowly start contracting the money supply. So he caught the market off guard. And in a few years, we can determine if that was indeed a historic moment. I think it was.

The FED-announcement above all marked the beginning of an unclear policy. So far the FED has been careful to explain and predict its own moves to the market by providing so-called forward guidance. While a bit unconventional, the market has been getting used to this guidance and has also responded to the earlier announcement of more restrictive monetary policy. This response may in turn have led the FED to change its previous opinion on the timing of tapering.

What may happen now is that the market and the FED get entangled in a dance where neither party knows whether to lead or to follow. Both are looking at each other while trying to find out if the economy itself is getting in a better or worse shape, as a result of their dancing. Rather than leading the dance, based on the music, the FED is now adapting to the dance partner as well.

It's this ambiguity of the FED and increased unpredicatbility that may well make yesterdays announcement a historic one.

The art of reserve banking (at the Zuid-as Amsterdam) !

Reserve Banking is an art. While Draghi and Bernanke are highly qualified and professional economists, they also master the art of performance. As true actors, they use their voice, their remarks, eyebrows and somewhat vague statements to provide hints and indications that the market then swiftly responds to. It is something you can't learn from the books. It's an art that can only be mastered in practice.

Since this year, the Zuid-As in Amsterdam is also home to the art of reserve banking. But it's a bit different. I heard about it yesterday, when visiting the Holland Financial Centre. From high up in the nearby Symphony building I looked down onto a small rectangular area of the Art Reserve Bank, well fenced, with cameras and three small office buildings. One is the minting press, the other is the teller and the third one was hard to identify. It looked like this:



The Art Reserve Bank: an experiment

What happens there is a unique experiment. A group of artists have set up, without any monetary funding, a so-called Art Reserve Bank. The plan was there for some time, but as the financial crisis came along, it became easier to convince sponsors to join a project that questions the value basis of money. The main idea is that there is far too much money circulating in the world and that the crisis demonstrates that we need a new approach towards money and debt. And in the experiment, art (or: the intrinsic value of human artistic expression) becomes the money. And thus helps to freshen up or minds and stimulate us to re-think our concept of money.

The idea is that for a period of five years, each month 400 coins are minted. These are 4 series of 100 coins per week, costing 100 euro each. For each month: a different artist is asked to design the coins, which all bear the same backside with the motto: ARS PECUNIA MAGISTRA: Art is the teacher of money. A nice motto and also a tongue-in-cheek reference to the Amsterdam Zoo that bears the motto: Natura Artis Magistra (Nature is the teacher of Art).

Anyone can buy coins and thus becomes a member of the Cooperative Art Reserve Bank (Kunstreservebank). All holders of the coin are thus the collective owner of the bank. Of the 100 euro costs, 90 % is used to pay for the operational cost of the experiment and 10 % is withheld as a 'cash reserve'. Should a buyer not appreciate his/her work of art, he can return it to the bank and get the original value back with a 10% interest fee. There is also a dealing room on the site of the bank, for those who wish to buy or sell their coinst. And at the end of the five years, all owners of coins can collectively decide what will happen with accumulated capital (if there is any and if the bank stil exists).

Money, dreams and art

The experiment challenges one to consider: what is happening in our world of money and value?

For me, the Art Reserve Bank made me realize that there may now be so much difference between their coins and the official legal tender in circulation. Both coins are the product of our imagination, dreams and creativity. Which is quite clear for the Art Reserve Bank currency, but may be less clear for the euro. So let me try to explain.

What happened over decades is that we moved from a mentality of: save first, spend later, to a mechanism of: spend first, repay later. If your story about the future would be probable enough (having a job, education etc) some bank would lend you money. And the same thing was true for businesses. Essentially this is a mechanism where tough choices are made. If you don't have the job or a solid story explaining how you can repay in the future, you don't get money. Which all sounds very realistic.

Fact is however, that with hindsight we can now see that banks, consumers and companies have on a large scale lived in dream worlds with expectations of future income, growth that were not realistic after all. Money was created, lent on the basis of these dreams and imagination. And part of that money is now in our pocket. And we also know that some of the debts are definetely not going to be repaid in the future.

So wouldn't it be fair to state that some of our euros are just as much the result of our imagination, as the Art Reserve Bank coins?