There is an urban legend that there is a looming Bourbon Supply Crisis. (Heaven Forfend!) Meanwhile, American Pharoah, as expected, won the Kentucky Derby. Both circumstances contain a homey lesson about the Federal Reserve System’s conduct of monetary policy.
Let’s start with bourbon. According to a recent article by Jake Emen in Eater.com, Is the U.S. Poised to Run Out of Bourbon? dispelling the myth of a looming bourbon shortage:
The demand for bourbon is overwhelming. In the past decade, there has been a nearly 40 percent growth in sales of bourbon and Tennessee whiskey in the United States, according to the Distilled Spirits Council of the United States (DISCUS).
"We're growing so dramatically that we've outgrown any reasonable expectations," says Jim Rutledge, Master Distiller of Four Roses, one of the iconic, major Kentucky bourbon distilleries. "It's just out of sight."
…
Meanwhile, an IWSR survey commission by Vinexpo projects that global bourbon sales are predicted to increase nearly 20 percent more in the next five years. Not everyone has faith in those numbers though, and plans based upon future growth have come back to hurt distillers in the past.
"Long-range findings in this business is really long-range guessing, and I wouldn't even call it educated guessing," explains Rutledge. "It's very difficult to determine consumer trends, and looking back at previous years and what's been happening, that obviously didn't work."
The only thing worse than not having enough whiskey to sell to people is having vast rickhouses lined with whiskey-filled barrels that nobody wants to buy. It happened in the 1970s as many American consumers shifted away from whiskey, instead turning toward vodka and rum. This led to the demise and consolidation of brands, and it's a hard-learned lesson which remains in the back of everyone's mind even in today's bullish bourbon market.
“Vast rickhouses lined with whiskey-filled barrels that nobody wants to buy….” Kentucky has more barrels of this elixir of the gods (4.7 million) than it does … citizens (4.3 million) reports The Atlantic Wire. Even this doughty bourbon drinker would have a problem making a material dent in a liquidity crisis of the magnitude described by Mr. Emen….
Now imagine how vastly more complex is the calculus for the demand for… dollars. Quantum physicist Niels Bohr once crisply observed, “It is exceedingly difficult to make predictions, especially about the future.”
The Fed, while operating with astonishing impunity, is by no means exempt from Bohr’s Aphorism. Dr. Richard Rahn, in the Washington Times:
The Federal Reserve had forecast the U.S. economy to grow about 4 percent near the beginning of each year for the last five years. But during each year, the Fed was forced to reduce its forecast until it got to the actual number of approximately 2 percent. (Other government agencies have been making equally bad forecasts.) These mammoth errors clearly show that the forecast models the official agencies use are mis-specified and contain incorrect assumptions.
Even the occasional career Fed official, among others, admits -- here and there -- how unreliable the modeling proves.
Is there a better way? Indeed, and the recent win by American Pharoah in the Kentucky Derby suggests it. American Pharoah was the odds-on favorite… and won. Upsets occur, and with some regularity. That’s what makes horseraces! That said, the odds, set by the bettors, consistently track pretty well with reality (or betting on horseraces simply would cease to occur).
Group intelligence consistently proves a better judge than does experts, however talented and well equipped (such as the Fed’s hundreds of PhD economists). As James Suriowiecki wrote in his bestselling The Wisdom of Crowds:
A classic demonstration of group intelligence is the jelly-beans-in-the-jar experiment, in which invariably the group's estimate is superior to the vast majority of the individual guesses. When finance professor Jack Treynor ran the experiment in his class with a jar that held 850 beans, the group estimate was 871. Only one of the fifty-six people in the class made a better guess. ...
[T]he group's guess will not be better than that of every single person in the group each time. In many (perhaps most) cases, there will be a few people who do better than the group. ... But there is no evidence in these studies that certain people consistently outperform the group. In other words, if you run ten different jelly-bean-counting experiments, it's likely that each time one or two students will out-perform the group. But they will not be the same students each time.
Suriowiecki writing, in 2004, at Forbes.com: “Just as Google’s PageRank encapsulates the knowledge of Web users, so does a market price embody, as the economist Friedrich Hayek suggested, all of the tacit knowledge and wisdom of investors and traders.”
One lesson from both the bourbon industry and the Kentucky Derby has to do with the folly of central planning. Central planning is a widely discredited practice to which elite monetary (and other) economists, Fed officials, and rainbow-unicorn-chasing Progressives still bitterly cling. Yet the historical data persuade me that a “Treynor Rule" would functionally be superior to the Taylor Rule, or NGDP targeting.
By allowing the markets themselves to determine their desired liquidity balances, a great deal of inefficiency is subtracted from the markets. No longer would $5.3 trillion a day be exchanged, as now, to hedge the risks of, or speculate on, currency fluctuation.
Historically, the way markets were allowed to determine their desired liquidity balances — and, in the process, set the economy’s interest rates in an organic way — was by the monetary authorities defining the nation’s money as, and making it convertible to, a fixed weight of gold … and adhering to the “rules of the game” to keep it there.
The classical gold standard was not one of carrying around gold coins in leather purses. It simply meant that when the “price” of gold rose from $35 an ounce to $35.01 an ounce, the monetary authorities would withdraw a bit of currency (until the price subsided again) or, if the price subsided to $34.99, inject a bit more currency (until the price rose again). It represented a “real time” rather than “batch” information processing system. It worked imperfectly but much less imperfectly than what we now have.
This may have been what then-World Bank Group president Robert Zoellick meant, in a widely noted FT column where he wrote, in part:
The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.
And what Bundesbank president Dr. Jens Weidmann meant when he stated:
Concrete objects have served as money for most of human history; we may therefore speak of commodity money. A great deal of trust was placed in particular in precious and rare metals – gold first and foremost – due to their assumed intrinsic value. In its function as a medium of exchange, medium of payment and store of value, gold is thus, in a sense, a timeless classic.
Or what analysts from Deutsche Bank meant in stating:
[G]old is not really a commodity at all. While it is included in the commodities basket it is in fact a medium of exchange and one that is officially recognised (if not publicly used as such). We see gold as an officially recognised form of money for one primary reason: it is widely held by most of the world’’s larger central banks as a component of reserves. We would go further however, and argue that gold could be characterised as ‘‘good’’ money as opposed to ‘bad’ money which would be represented by many of today’s fiat currencies.
As for bourbon, per Emen, “New stills must be produced to make more bourbon, new warehouses are required to store more barrels, which themselves have been battling scarcity issues due both to demand and inclement weather, and then that bourbon must sit, and sit, and sit.” Not so money. As Dr. Weidmann stated in the same speech, “Indeed, the fact that central banks can create money out of thin air, so to speak, is something that many observers are likely to find surprising and strange, perhaps mystical and dreamlike, too – or even nightmarish.”
Forty economists (few of them monetary) unanimously condemned the gold standard in a survey taken a few years ago. Still, Bohr was, and is, right: “It is exceedingly difficult to make predictions, especially about the future.” As for monetary policy, time for the Fed to reassess its operating protocols. It is high time to replace groupthink with group intelligence.
