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Tuesday, October 22

"Look at the charts, Frank." U.S. monetary policy gone to the dogs.

It's come to my attention that many people are confused about U.S. monetary policy, viewing it as an arcane and even magical preoccupation of economists whose mysterious and seemingly arbitrary decisions greatly affect the financial affairs of ordinary Americans. Actually, the workings of U.S. monetary policy are easy to understand if you know there are actually two policies: the internal policy, which is controlled by Frank, who works for the Federal Reserve, and external policy, enforced by Petunia, who works for Treasury.

These policies don't so much work in tandem as coexist in an uneasy detente that has been broken on occasion, like the time Petunia ate Frank. It's okay. The Fed got a replacement and there'd been more than one Frank before then, just as there's been more than one Petunia since. It was her first day of work, the handler accidentally let go of her leash. Since then the Fed has employed scouts to make sure Frank and Petunia aren't being walked at the same time.

And no, the handler wasn't fired. He was given a promotion.


Now who is Frank? He's a chihuahua and the linchpin of the system by which the Federal Reserve Open Market Committee settles their disagreements about the meaning of U.S. economic indicators. They spread all the statistical charts on a large conference table, put Frank on the table, then say, "Look at the charts, Frank."

(Some of the charts are actually graphs but this is a superfluous detail from Frank's point of view.) Then the committee members take notes on Frank's expression as he looks at each chart. Then they figure an average of their impressions of his expressions to determine where to set interest rate targets.

If that sounds like a screwy system it's an improvement on the old system. The FOMC used to slaughter a chicken on a full moon night at a parking lot in Northeast Washington and read its entrails. But there were always fights: You kill the chicken this time. No I killed it two times ago.

Finally they hired a Voodoo practitioner who called herself Madame LeVoon to kill the chicken. That system of reading economic indicators lurched along for a time. Then Madame LeVoon lost money in a stock market downturn that was a direct result of the Fed's misreading of entrails. The next time she saw the committee she said, "Hear what I'm telling you. A dog could read the signs better."

Of course they didn't hear. The next morning a member of the FOMC broke his leg in a freak fall. The next morning another member broke his arm in a freak car accident. That afternoon the FOMC members who weren't wearing a plaster cast, their hearing much improved by then, went to a pet store and bought the first dog they saw, which was a chihuahua.

That's how the new system started; again, there have been a number of Franks since then. Also that's where the economic slang term "squishy" comes from, as in "The manufacturing sector numbers for this quarter are squishy." Sometimes they forget to walk Frank before a meeting. It's not like a tiny dog can hop off a high conference table to scratch at the door. Papers spread around the table, you get the picture.

But then they have to note which chart Frank chooses to squat on. So you would think they wouldn't forget to walk Frank, and sometimes they don't forget. These are the times when a scout reports that Petunia is being walked. As to why they don't simply take Frank to an executive washroom at those times -- because the same system tends to generate the same mindset, no matter how different the people. There are always fights: You take Frank to the washroom this time. No I took him two times ago.

In the end, let him do his business on a chart if he can't wait.


Who is Petunia? She stands four feet high and looks something like a cross between an English mastiff and a cougar. If that sounds like a strange dog, you should see some of the creatures that defend currencies of other major trading nations.

The first Petunia went to work for Treasury in 1973. This was when the Bretton Woods monetary system ended. At that time Treasury set up a department to enforce the new external U.S. monetary policy, which boiled down to a simple mandate: No central bank tries to dump the U.S. dollar, no central bank gets hurt.

Petunia, her handler and pilot are the only employees in the department. She has her own jet plane, Air Force Petunia, which by tradition is piloted by a member of the family in the Appalachian Mountains that breeds and raises Petunias.

All Petunias are very intelligent. Mastiffs were originally used to guard large English estates, so the dogs were bred to have a fine sense of judgment; after all it wouldn't do to mistake a new vicar paying a courtesy call for a poacher. Because of this inbred intelligence and because cougars are very shrewd, Petunias are only taught three commands: "Snarl," "Sit for Bacon," and "Don't eat the U.S. President or the dog groomer," with the rest pretty much left to their judgment.

As to why there's no command not to eat the Treasury Secretary, in the earlier years it was concerns about KGB infiltration, then later moles for China's government. For this reason there are entirely separate elevator systems at Treasury. Petunias are bright but they can make mistakes.

Petunia and the East Asian Financial Crisis

It so happens that the second command taught to Petunias was the biggest factor in the Asian Financial Crisis spilling out of Asia. It all started when some central bankers in ASEAN countries began ruminating in front of a microphone about making the Japanese Yen their major reserve currency instead of the U.S. dollar. This activated Petunia. She was only supposed to frighten a few Asian bankers and heads of state but when it came time to give the stand-down command her handler, who was new at the job, said, "Sit for biscuit."

When she wouldn't obey what sounded to her ears like gibberish the handler whapped her on the nose with a rolled up newspaper.

Try to put yourself in Petunia's place to understand why references to the department manual were no use after that. Finally the handler got a choke leash on her and yanked her aboard her plane, all the while hissing, "Bad dog!" at her.

When the pilot heard her whimpering he threw the handler off the plane. Then he translated her yips and whines into a flight plan and jetted her to various financial centers, with layovers at the farm in the Appalachians so she could get moral support from family and friends.

(These layovers explain why, as Larry Summers told the BBC's Katty Kay this March, what had started as a financial crisis in East Asia seemed to die down for a time before suddenly appearing in another country outside Asia.)

What the handler should have done immediately was phone the White House for help; instead, he followed Air Force Petunia around the world on commercial flights -- first class airfare, I might add, which of course he charged to his expense account. It was only when Petunia began chasing traders around the floor of the New York Stock Exchange that he threw in the towel.

President Bill Clinton personally gave the correct stand-down command. Then using three pints of bacon ice cream -- two pints for Petunia and one pint for Bill to keep up his strength through the ordeal -- he coaxed her into his limousine. She was returned to Treasury no worse for wear if you don't count a case of injured pride.

No, the handler wasn't fired. He was transferred to a desk at State where he helped write U.S. trade policy on China.

Speaking of Larry Summers, there were rumors at the time that Petunia bore a striking resemblance to him, but then for years there were rumors she was the spitting image of George Soros. Having seen the present Petunia I can tell you that she looks nothing like either man. I also saw photographs of earlier Petunias, which the handler has preserved in a beautiful gold-embossed album. Here the best I can say is that when you've seen one photo of a strange looking dog wearing an enormous hand-washed, hand-ironed pink satin bow you've pretty much seen them all.

Pundita's Adventures Researching U.S. Monetary Policy

As to how I know about Petunia -- in the same way I know that the Ghost of 1929 haunts the Federal Reserve building in Washington after midnight. Late last year I decided to research U.S. monetary policy in depth. This kind of research always involves field work. Lucky for you Pundita is a master of disguises when it comes to field work. This gave me great insight into the way America's finances are actually run, which I've been able to pass along to you in several posts this year.

I can't reveal much about my disguise at Treasury except to say that when your only coworkers are a dog and a man who is devoted to the dog, you tend to be talkative with the dog groomer. This might be why Petunia gets a shampoo at least twice a week, which by the way she very much enjoys.

With regard to my research at the Federal Reserve, again I can't reveal much about my disguise but I will observe that when your system of analyzing the economy boils down to a game of Pin the Tail on the Donkey you might as well make it a real party. Who's the first person you call when you want to plan a party? The party planner, of course. And everyone in an office loves the party planner because they get to choose what kind of ice cream and cake they want and pick out decorations and party prizes. This means party planners always get the run of an office.

So to answer Sleepless before she sends another email: yes, with my own eyes I have seen the Ghost of 1929. As to how I know it's that particular ghost and not any ghost, in the same way I know that the racket the ghost makes after midnight is the sound of 40,000 1930s-era bank teller windows slamming shut at the same time. There's a mathematician who likes to burn the midnight oil at the Fed and who's on speaking terms with the ghost. My own view is that it never pays to get conversational with a ghost. But the mathematician told me the story when I promised there would be strawberry ice cream for everyone after the next FOMC meeting. And yes, I also saw Frank while I was at the Fed.

Pundita Meets the World's Big People

I also attended the World Economic Forum in Davos-Kloster, Switzerland. As to how I managed to crash that gathering of the world's Big People, again I can't reveal much but I will say that this year at Davos it helped to wear 30 pounds of 24 karat gold jewelry borrowed from Charlotte ("Remember, you break it, you own it"), an I.D. tag that read "Tajikistan" and to be accompanied by two nervous-looking young men from the City of London who kept telling the hall monitors, "She's looking for the sessions on oil and gas exploration and how to buy some banks."

See this is one reason not to get conversational with a ghost. I don't think the Ghost of 1929 recognized me underneath my fetching ethnic disguise when it showed up at Davos, or it might have asked what the party planner was doing there. Anyhow, as I mentioned in April, the big news to come out of this year's Davos confab, which you will only read about here, is that the ghost put in an appearance.

So much for the belief that the ghost won't appear in Switzerland because it's scared of Swiss bankers. Maybe at one time it was scared of them but obviously no more. Here I should add that very few at Davos actually saw the ghost. It made its presence felt though odd squeaking noises that one attendee, a student of the French Revolution, identified as the sound of a portable guillotine slowly being wheeled into place, and by uproarious laughter.

Battles With Wall Street Zombies

I also went to Manhattan to investigate the financial sector, which is part of U.S. monetary policy on account of the U.S. banking system was converted into a monetary tool decades ago, with the results you see today.

I don't think it would do any harm to reveal that for this phase of my research I joined the midnight shift of a crew that cleans offices in Wall Street firms. No names, but I can tell you these firms are part of what's known as the Global Shadow Banking System -- this being the system of non-bank financial institutions that offer banking services.

It was actually the shadow banking system, not what passes for the U.S. banking system, which crashed in 2008, even though several banks were and still are part of the shadow system. The crash caught economists in government and the financial sector unawares, partly because nobody thought to figure rehypothecation into their calculations. And Frank, bless his heart, can't read equations. So it wasn't until 2010 that two guys at the International Monetary Fund figured out that everyone had underestimated the size of the U.S. part of the shadow banking system by 5 trillion dollars. (I am not making that part up.)

The other part was that the math wizards who designed the hideously complex mortgage derivatives trades didn't understand the mortgage business, and the people who sold these derivatives didn't understand the math behind them but were too proud to admit this. (I am not making that part up, either.)

Happily, the globe was saved from crashing by a series of massive taxpayer-funded bailouts led by American taxpayers. However, government explanations to the American Little People about why it was vital that their tax money bail out banks and insurance companies they'd never heard of on account of these firms weren't located in the USA tactfully avoided mentioning the zombie problem.

This problem was first described by an American professor, who was trying to explain to the public in plain English why FDIC insurance paid by banks for decades hadn't been enough to cover losses in the crash of the savings and loan banking industry in the 1980s. The losses had to be covered by the taxpayer because the S&L industry was too big to be allowed to fail. The professor explained that the bailout had created zombie banks: banks that were deader than a doornail but which carried on an undead existence of sorts by feeding on the living taxpayer.

The same problem emerged from the bailout of the shadow banks. And so the truly hair-raising phase of my field work. It's one thing to deal with a ghost, but fending off the undead and trying to vacuum carpets at the same time while the crew boss shrieks, "Nobody bump into the supercomputers!" calls for the reflexes of a ninja.

But from this adventure I can report that the zombies on Wall Street, which by the way has become a euphemism for the Global Shadow Banking System, are still undead and well.

Pundita Joins a Cult

After completing my investigation in Manhattan it was home to Washington. I returned the gold jewelry intact to Charlotte. Of course she got it assayed, just to make sure. Speaking of Charlotte, to keep the peace I corrected my "Tofu and the Police State" post after she read that I'd termed her gambling "illegal." If you say you've never heard of a possum that can read -- how else could she work an Ouija board? She told me that none of her gambling was illegal; that what I considered illegal was actually unorthodox gambling. She got that from reading that IMF chief Christine Lagarde had called the Fed's massive quantitative easing experiment "unorthodox" monetary policy.

Then I transferred my field work to the world's Little People. This was how I discovered that many Americans belong to a pagan cult. I personally witnessed their bizarre rituals, which involve bowing to an image of a sacred cow and chanting, "I must go into debt to get a good education so I can get a good job and spend my way into bigger debt so I can save my way to being rich when I'm old enough to wear Depends diapers."

I will tell you I was so shocked by this display that I nearly blew my cover when I gasped, "Have you all lost your mind?"

I diverted attention from the gaffe by thundering in Hungarian, "Take me to your leader or I'll rat you out to the Secret Service for running a Ponzi scheme!"

(Amazing but true, the Secret Service got involved in investigating Ponzi schemes. This happened when the schemes began proliferating like mice in the wake of 9/11, which saw the FBI greatly occupied with investigating terrorist matters.)

I had to wait some time but finally one night I was ushered into the presence. My jaw dropped at the sight that met my eyes. There was a chihuahua, got up in a tiny powdered wig and velvet waistcoat and seated on a throne.

"Meet our leader, Bernard de Mandeville," whispered one cult member.

I said, "That's not Mandeville. He's dead. He's been dead for 300 years. That's Frank."

Then I grabbed Frank and ran like hell. I returned him to the Fed the next day with the advice to keep a closer eye on him in future. Then the fights started: It's your turn to keep an eye on him. No it was my turn two times ago.

Closing Thoughts

Well I hope all that clears up any confusion about U.S. monetary policy. But I would like to emphasize that not only has Bernard de Mandeville been dead for 300 years, he never advised that governments attempt to reverse engineer the Paradox of Thrift. Nor did he advise that the banking system be virtually destroyed in the service of reverse engineering an economy, as if business cycles were a contraption that could be tweaked whenever it seemed to be malfunctioning.

And if John Maynard Keynes had lived to see middle-income Americans walkinig around in $200 designer jeans and sneakers bought on credit, I think he would have regretted mentioning Mandeville's Paradox of Thrift when he wrote his 1930 "A Treatise on Money." He advised that governments do deficit spending in the face of a looming recession. Governments -- not individuals.

Yes, I understand that most Americans can't read economic indicators in the way Frank can and so can't see signs of a looming recession. But then why do these Americans live as if they can see the signs?


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