It is 2:15 AM PT on a Friday night, so it seems like as good a time as any to talk about a commodity unlike any other. This is the value behind the value, the power behind the curtain - the reason for unreason - the one ring to rule them all: central bank credibility. *a thread*

When we talk about credibility in economics more generally, the topic is ephemeral - we try to pin down creditworthiness of borrowers with neural network and AI-infused contrivances like the Fair Isaac score (ie - FICO) but ultimately two parties either trust one another or not.

When we’re talking about #bitcoin or #MMT the entire debate is framed in a well-established narrative about free-floating fiat currencies and sovereign bond markets (ie - countries borrowing money from the international banking system mediated via their central banks)

The entire reason for the mechanism in place today (not often overtly discussed) is that in the absence of a gold standard, “fiscal discipline” in countries is judged by the free market to be a function of this weird thing called “central bank independence” which is political.

Just so you can see I’m not making this part up, let me direct you to a very nice little article over on @Investopedia that discusses the pros and cons of central bank independence in a balanced way: https://www.investopedia.com/articles/insights/082416/should-central-banks-be-independent.asp

Had to make some ramen but am back now to finish the thread (I do have a point after all) and that point is this: central banks are not credible if they are trusted to pay something back per se, their credibility derives from their ability to *checks notes* ignore the people.

So this is not even as big of an exaggeration as you might think. Central banks have the ability to mediate (and exacerbate) boom and bust cycles in their currency zones. We entrust them to not do certain things with this power, mainly, not to completely collapse the economy.

Other than some very broad outcomes-based “mandates” the *how* of how the mandate is achieved needs to be conducted essentially by mathematicians and modelers, not politicians, Wall Street, or democratically-controlled institutions. Central bank credibility comes from outcomes.

There are a few very large problems with this. In general, people like the idea of little ‘d’ democracy because it gives the average citizen a formidable freedom and responsibility to participate in the government of their society. Money undoubtedly influences that society.

So herein lies the mismatch: hitting a 2% inflation target requires math, measurement, flexibility, discretion, and many many “policy tools” to put digits in databases whenever and wherever necessary for price stability, but people want to have input on the *how* of policy.

And when I say people, I don’t just mean a random Hollywood actor or Joe the plumber - I mean elected senators, bureaucrats, lobbyists, presidents, and all sorts of people want to influence what central banks do. Their credibility is in their resistance to that strong influence.

Why is there inherent value for fiat currency when “external influences”appear to have no effect on central bankers’ reaction function? Well, quite simply, for the same reason people believe #Bitcoin has value: the algorithm dictating bitcoin supply growth is cold and immovable.

A money supply run by an algorithm though is a money supply that doesn’t need central bankers or politicians to fret about where the next tranche of currency might come from. We already know. It comes naturally, as miners unlock it from the completely premeditated system.

So in many ways such an innovation would be a relief for central bankers that must constantly prove their virtuous resistance to political influence. Algorithmic money is just robots taking central bankers’ jobs away through automation. No more awkward calls from US presidents.

But we don’t yet live in a world redenominated into algorthmic, deflationary cryptocurrency - we live in a fiat world. If the perception exists today that a country will goose their economy to “buy votes” then that nation gets punished in currency markets. Turkey is an example.

The Turkish leader essentially wants to have his cake and eat it too: he wants the lowering of interest rates to win him favor domestically, and he wants the world to believe that high rates cause inflation (they do not): https://mobile.reuters.com/article/amp/idUSKBN2BU252

In the course of making this very dubious point, Turkey has shredded the value of its currency because markets believe the central bank in charge of the Turkish lira currency zone is going to live in opposite land, and basically do whatever Erdogan says no matter how ridiculous.

This is a classic case of a central bank or monetary authority losing its credibility in the eyes of the free markets. The market essentially believes there is maybe just a handful of coherent methods for safely managing a currency zone - go too radical and credibility is nil.

So credible central banks are ones that can be both Volcker and Bernanke: they can handle the thermostat when it gets hot or gets cold - but the present pandemic crisis, presumed to be deflationary, has ushered in a true question mark over the US dollar and Fed credibility.

To continue with the thermostat analogy, the issue today is embedded in the idea that the USD currency zone has innacurately measured inflation for years - like setting a thermostat to 72 degrees in your unheated garage, while the temperature in your house goes to 100 degrees.

Fed watchers like @DiMartinoBooth who worked at the Dallas Fed highlight this idea that inflation measurement using Core CPI is done in such a way now as to fool our central bankers into thinking they will essentially never need to channel Paul Volcker again to fight inflation.

So while #MMT wants us to be explicit about the relative infinitude of US dollars, and #bitcoin wants to focus on the political desires of people to have deflationary currencies of fixed quantity, central banks know that they risk being unable to what they say they want to do.

In some sense, just like in the modern debt-money system your credit score is one of the most powerful determinants of wealth, on the international stage central bank credibility is one of the purest types of wealth of nations. If your fiat is believed to be unending, it is over.

In conclusion, central banks can get out of this mess: they can choose hittable targets and audit how they measure inflation in the Core CPI. That is why I’m a big fan of a radical abandonment of the 2% inflation target, because the failure to hit it has eroded Fed credibility.

One reason (maybe) they can’t hit it is because currency zones aren’t neat and tidy. They aren’t all these solid bathtubs that you know when to stop filling them with that zone’s fiat currency. They leak, and sometimes US dollars (for example) become popular in other countries.

My point is that if the inflation target was 0.5% then we would have been over target for years in the US and would have ignored things like the “taper tantrum” in 2013 and just let rates rises, stocks fall, and organic repricing of risk assets to occur: https://www.investopedia.com/terms/t/taper-tantrum.asp#:~:text=The%20phrase%2C%20taper%20tantrum%2C%20describes%20the%202013%20surge,of%20money%20it%20was%20feeding%20into%20the%20economy.

The entire 2013 episode was really another chapter in the erosion of Federal Reserve credibility, because allowing for stocks to fall or bond yields to rise would not have been singularly catastrophic. Stock markets becoming frothy should not be the policy transmission mechanism.

Finally, consider what it would do to markets if instead of permitting mission creep - giving the Fed a full employment mandate alongside price stability - they had stuck to their knitting, not reached for emergency powers in 2008, and just let markets work it out. *end thread*