Episode 10 - A Few Words
A few carefully chosen words from a central bank can save an economy in panic or send it spinning out of control. Three stories today illustrating the high impact of Centralverse language.
Intro
I’m Alexander Bagehot, and you’re listening to The Bankster Podcast. This is Episode 10 - A Few Words. Every episode we dive into the intricate world of central banking! I use one or two pieces of news from the Federal Reserve or monetary policy from around the world to summarize, translate, and explain a few points from the Centralverse. Now the Centralverse is the deep, the fascinating, the ever changing, and the incredibly consequential world of central bankers and the economies they attempt to support.
On the last episode, I began by saying that, “When central bankers speak, the world listens.” I went on to explain the purpose and modern evolution of the Federal Reserve’s communication strategy - called Forward Guidance; however, I didn’t talk about any of the actual words that they’ve said. Well, today I am going to dedicate a full episode to sharing three stories from central banks’ recent past that illustrate the astonishingly high impact of words spoken by Centralverse leaders. The first is an unexpected misinterpretation of Chairman Ben Bernanke, then two successful institutional communications at times of panic - one from the Bank of England and the other from the Federal Reserve. If you missed Episode 9, I’d recommend going back and checking it out. For today’s episode I’m going to structure the whole episode around the three stories and skip the traditional news section. So without delay, let’s wind the clocks back.
The Taper Tantrum
Story number one - The Taper Tantrum. This is the story of a trillion dollar investment, two speeches, and one man at the center of it all. But let’s start at the end.
It was a warm, spring day near the end of May, 2013. In Washington DC a group of United States Senators and Congressman had invited Ben Bernanke, the Chairman of the Federal Reserve at the time, to share his Economic Outlook. This group of Washington politicians made up what was called the Joint Economic Committee, and they wanted to hear from the man leading the most important financial institution in the country. How did he think the economy was performing? What was the Federal Reserve currently doing? And most importantly, what actions might they be taking in the near future?
It had been four years since the official end of The Great Recession. The stock market had recovered and housing was looking better. On the other hand the unemployment situation was still poor and inflation was running below the 2% target. The economy was giving off lots of mixed signals.
The custom of these Federal Reserve testimonies on Capitol Hill is for the Centralverse leader to read a speech that is meticulously prepared. Following the speech there is a question and answer exchange between the committee and the speaker. This spring morning was no exception. Ben Bernanke read his speech, word for word, outlining his views on the economy. Of the 20 minute speech, one word of one sentence would stick on the minds of investors across the world. That word was - reduce. But hold on. Keep that word, reduce, in your mind. Before we go any farther with the second speech, we have to wind the clocks back another few months to the first speech - to see where this all started, and why the word reduce would be remembered.
Now we are in August of 2012, the previous summer, and thousands of miles away from the great halls of Congress. In fact we are at the foothills of the awe inspiring Grand Teton peak of the Rocky Mountains. Near the end of every summer the most powerful players in the Centralverse gather at a lodge in Jackson Hole, Wyoming. This annual symposium is put on by the Federal Reserve Bank of Kansas City and is heavily followed by policy makers, the media, and investors alike. Ben Bernanke had originally planned on giving a speech on the implementation of the recent financial reform act; however, he was watching the economy struggle and was convinced that there was still more that the Federal Reserve could do to strengthen the outlook. He had been invited to be the opening speaker at the conference, and it would be behind this podium that he would make his next move.
According to his book, The Courage to Act, Bernanke didn’t want to make an all out announcement or commitment to further action in this setting because he didn’t want to alienate the other members of the FOMC, whose next scheduled meeting wasn’t for another month. So his speech was in classic Centralverse-ease. In the book Bernanke says, “I could not make definitive promises. But just by discussing the possibilities at length I would send a signal that we were prepared to act” (pg 484).
By simply using his spot on the pre-scheduled agenda, Bernanke gave the perfect example of Forward Guidance. By simply altering the topic of his speech Bernanke literally changed the direction of the economy. It was quite clear to all that were listening to the speech or read about it in the following days that the Fed was going to take further action. And when the Fed takes action, the economy moves.
At that FOMC meeting the next month, they did in fact announce another round of Quantitative Easing or QE, which is simply another policy tool that central banks have to encourage growth. This time around the FOMC gave no notice of when the QE would end. I can’t overstate the importance of that last part there. The actual words in the statement were, “until such improvement is achieved”. And that’s how it all began. The Fed committed to injecting $85 dollars into the system every month without a definite end. The scale is incredible!
So now let’s fast forward to where we left off at the meeting in Washington DC the following spring. Remember where we were? Behind a very different audience, Bernanke had used the word reduce. Now let me read you the full sentence, “At its most recent meeting, the Committee [meaning the FOMC] made clear that it is prepared to increase or reduce the pace of its asset purchases” Here he is referring to the $85 the Fed was injecting into the banking system every month.
To a passive listener the significance of this sentence might be understandably overlooked. Bernanke just said maybe they will slow down the dollar injections, maybe they won’t, right? Yes, that is true, but there is a lot of meaning packed into that idea. See, even the hint of a slowdown or the possibility that the Fed might reduce the amount of monthly stimulus caused markets to panic.
You want to think of the Federal Reserve as a hand holding up a fragile economy. To many people the idea that the Fed would reduce those dollar injections was like saying the Fed was going to pull the hand away and let the economy fall flat on its face. Listen to a few titles of news articles from the day and the days after, “In Bid for Clarity, Fed Delivers Opacity”, “Fed Leaves Markets Guessing”, and my favorite, “Bernanke Taper Tantrum”. A tantrum is exactly what the markets threw for the next few months. Eventually the markets did stabilize but there was significant increase in volatility and confusion.
Wow, one speech in Wyoming causes calm and excitement about the economic future, and another few words from a speech in the capital less than a year later causes panic and huge market volatility - drastically different responses. I love this experience because it demonstrates the power of the words of central bankers when those words are describing their thoughts about the future.
Central banks are established by the government. When the government writes the law that creates the central bank they have to include what the high level goals of the new central bank are going to be. These goals have a special name - mandates. Most central banks have just one mandate- keep inflation at 2%. The United States has a little broader mandated goal that includes maximizing employment. However, there is one other objective that central banks are constantly monitoring and in the long-run has a big impact on the official mandates - I am talking about financial stability. The words of the central bankers in the next two stories are much more direct than those that caused the Taper Tantrum, and rather than trying to describe the central bank’s plan for the future, these next two are about calming economies immediately after a traumatic event.
Story number two is about an event that happened about a month ago that consumed the financial, political, and cultural news. It’s time to talk about Brexit. And more specifically the Bank of England’s response to the historic vote.
Brexit
But first a 30 second review of what Brexit means. In 2013 David Cameron, the Prime Minister of the United Kingdom, was facing a very challenging election. To bolster his campaign and to soothe some in his party, he promised that if he was re-elected he would put forth a vote to the people - called a referendum. The voters would have a simple option “Stay in the European Union” or “Leave the European Union”. Well, Cameron won the election and followed through on his promise. The vote was held last month - June 23, 2016. Should Britain exit the EU? Or in other words, Brexit.
Although the polls leading up to the vote showed the leave and stay camps evenly tied, the financial markets (and the betting pools) had the stay camp winning quite handly. It was this high expectation that the United Kingdom would stay that made the financial turmoil so dramatic when the results came in with the opposite result.
Financial markets do not like surprises, and it showed. Stock markets in the United States, the United Kingdom, and Asia crashed 5% or more over the following few days. The Bank of England had prepared well and on June 24th, the morning following the results of the referendum, as panic was spreading, they did three things. First they released a simple, concise statement. Listen closely because this statement, although short, contains a number of essential elements. I’ll translate each of the three sentences that make up the statement.
“{Sentence 1} The Bank of England is monitoring developments closely {meaning they can see that people are going crazy, they aren’t going to do anything immediately, but they will keep their eyes open for anything that is damaging on more than the short term. Sentence 2}. It has undertaken extensive contingency planning and is working closely with [Her Majesty’s] Treasury, other domestic authorities and overseas central banks {here the statement is acknowledging that the problems and chaos are not isolated to England and that the Federal Reserve will be willing to help if needed. Also, as an American I have to say that adding the words “Her Majesty’s” before anything makes it sound so much cooler. Sentence 3}. The Bank of England will take all necessary steps to meet its responsibilities for monetary and financial stability. {So even though they aren’t going to act right now, they are committed to acting if the need should arise}.”
Three short sentences that, those versed in Centralverse language understand, calm and add confidence to the troubling situation. But this statement was not all. The Governor of the Bank of England, the highest ranked official in that central bank, also gave a 5 minute speech. The beginning to the video of the speech is rather ominous, where the Governor walks down a long, skinny hallway with a very solemn expression on his face towards a glass podium. But Governor Carney takes the opportunity to remind everyone that the financial sector, and specifically UK banks, are much much stronger than they were before the crisis - in fact he says the capital levels are 10x higher than pre-crisis. Expounding on the statement he promises that even if the capital levels turn out to be insufficient to maintain stability, the Bank of England is ready to add £250B to the system through regular channels. And beyond that, “we will not hesitate to take any additional measures required to meet our responsibilities as the United Kingdom moves forward.”
So far we have a statement, a speech, and finally (my personal favorite) an FAQ titled, “EU Referendum: your questions answered”. It’s easy to see, by the title alone, that this 3rd release by the Bank of England is different than the other two. The first two were directed to bankers, business owners, and foreign governments. This FAQ is directed towards the people of the United Kingdom. It reminds them that the country’s banks are safe and that their deposits in those banks are insured, i.e. no need for a bank run. And throughout the whole document there is this funny undertone that says, “Look, we didn’t want this whole thing to happen. We didn’t have anything to do with the messy politics of the whole process. However, now that it’s officially happened we will be here to help with the transition. Stay calm because the financial system is sound.”
By the end of the week after the Brexit vote markets around the world had calmed and were back up and on track to break new record highs. On the whole the Bank of England didn’t have to use their emergency powers or tap deeply into the reserves. That is an example of the power of words. Those three statements were enough.
Credit for the financial market recovery cannot be completely handed to the Bank of England. However, know that those words did have an impact, and if they hadn’t have been there (as the Federal Reserve was not there during the Great Depression) there would have been much darker troubles. Central bankers and those that have ears to hear them are learning the influence of Forward Guidance - the use of communication as an actual tool to improve the economy.
So we’ve heard two stories of central bank communication. The first about broad measured, long speeches at an economics conference and before a committee in congress. The second about a crisis that the Bank of England had time to prepare and plan for. This final story is also about a crisis - a crisis that the neither the world nor central banks had time to plan for.
Open and Operating
On the morning of September 11, 2001 the Chairman of the Federal Reserve at the time, Alan Greenspan, was flying home from a meeting in Switzerland. On this side of the Atlantic Roger Ferguson woke up that morning, prepared for the day, and went to work as he normally did. Ferguson was the Vice Chair of the Federal Reserve and took the lead when the Chairman was out. Just before 9:00 am on that fateful morning the North Tower of the World Trade Center was struck by a commercial plane hijacked by Al-Qaeda terrorists. Within the following 90 minutes, three other planes were hijacked and crashed.
From the window of his office in Washington DC, Ferguson could see the smoke rising from the Pentagon across the Potomac River. He knew that there was one thing that would exponentially increase the damage already done that day - a collapse of the financial system. The New York Stock Exchange did not open that morning, but there is much more to the financial system than stock or options exchanges. Remember that the lifeblood of the economy is credit. And banks and large corporations are highly dependent upon short term (often overnight) access to credit. During times like this credit freezes up. Meaning no one is willing to make loans to each other - and in fact often the opposite happens. Lenders call in their loans, which means they say to the borrowers pay us back right now.
One of the responsibilities of a Central Bank is to be the Lender of Last Resort. Ferguson was well aware of this responsibility and leapt into action. He released a statement directly to the institutions that work closely with the Federal Reserve informing them that the electronic system, called Fedwire by which all of the large dollar wire transfers occur was safe and would remain functioning. I can’t overemphasize the importance of Fedwire - at the time $1.6 Trillion was being exchanged through this system every single day. Imagine the economic damage that would be done if that trillion dollar market froze up.
The Federal Reserve Bank of New York, located just blocks from the World Trade Center was on emergency alert, implementing some of the Y2K policies that they had prepared for the year before. They opened their doors to refugees of the area. The contingency site in New Jersey was ready to take over operations. Back in Washington DC most of the Fed staff was sent home. Those remaining would stick with Ferguson to try and keep the economy from complete collapse.
Within hours the Fed released a statement to the public, “The Federal Reserve System is open and operating. The Discount Window is available to meet liquidity needs.” Like the statement by the Bank of England over a decade later, the statement was concise yet indescribably important. After such a traumatic event, this simple statement made clear that the Federal Reserve was there and ready to help for as long as would be necessary.
Through the Discount Window banks have access to daily credit from the Federal Reserve. On a typical day before 9/11 Discount Window loans across the country averaged $54M. On September 12th Discount Window loans passed $46B - 100x the previous average. With the help of New York Police and New Jersey state troopers the New York Fed also distributed over $425M in physical cash to banks in the area.
The Federal Reserve would intervene in a number of ways in the coming days and months in order to save the economy from a complete meltdown. But the first and most important step was communication.
The main sources for this final story came from a 15 minute video titled Open and Operating by the Federal Reserve Bank of San Francisco and an article called The Astonishing Story of the Federal Reserve on 9/11.
Conclusion
Each of the three stories discussed today demonstrates the benefit of clear and concise communication from central banks and the danger of miscommunication. They become pivotal moments in the economic swings of history. I recommend listening closely whenever central bankers speak. Their words carry heavy weight and those that can read and interpret their words will be all the better for it. If you go to www.thebanksterpodcast.com, scroll to the bottom of the home page, and sign up for the show notes, you’ll receive an email on Monday morning explaining how to receive notifications from the Federal Reserve. I’ll also include links in the email to all of the sources from today’s episode.
I’m excited to announce that to accompany this episode on central bank communications I have expanded the books section of my website. It’s called “Their Words” and it contains pictures of the largest, private, rare and valuable central banking book collection in the world - my collection! It might be the only private, rare and valuable central banking book collection in the world. Google doesn’t seem to know. But anyways, check it out and as always let me know what you think of the website, the podcast, and the Centralverse in general.
Today’s episode was written, edited, and produced by me, Alexander Bagehot. I dedicate this episode to Roger Ferguson. May I respond to the next crisis (personal or professional) with the level of composure and dedication that you did. And to everybody else, thanks for listening. I’m Alexander Bagehot, and I’ll see you next time on The Bankster Podcast!
