Submitted by Monty Pelerin via Economic Noise blog [6],
Would Salvador Dali make a better Federal Reserve Chairman than Janet Yellen or Ben Bernanke before her?
If that seems far-fetched to you, read on to understand the benefits Salvador Dali might provide for the Fed. Yes, Mr. Dali is no longer of this earth so you should feel free to substitute someone with similar skills. The point is that a man with his talents might be a better Fed Chairman than the economic hacks that are appointed.
Banking
Few topics are less understood (and more boring) than the mechanics of banking. Anyone who has taken an economics course was exposed to the bank-multiplier effect — how banks can “create” money via lending in a fractional-reserve system. John Kenneth Galbraith, a witty economist (no, that is not an oxymoron), said of money:
The process by which banks create money is so simple that the mind is repelled.
The simplicity of this process is understood by few non-economists. For economists the process is “so simple.” Those who understand the process and its implications may be “repelled,” although it is doubtful that the creation of money was what Galbraith had in mind. As a true Keynesian, Galbraith was in favor of utilizing money, particularly its creation, to manage and manipulate macroeconomic outcomes.
Salvador Dali as Fed Chair
Analogies can be effective in communicating otherwise complex topics. Dante Bayona [7] provides a particularly valuable one using Dali as the vehicle:
There is a story about the great Catalan surrealist painter Salvador Dali. It is said that in the last years of his life, when he was already famous, he signed checks knowing that they would not be submitted to the bank for payment. Rather, after partying with his friends and consuming the most expensive items the restaurants had to offer, he would ask for the bill, pull out one of his checks, write the amount, and sign it. Before handing over the check, he quickly turned it around, made a drawing on the back and autographed it. Dali knew the owner of the restaurant would not cash the check but keep it, put it in a frame, and display it in the most prominent place in the restaurant: “An original Dali.”
It was a good deal for Dali: his checks never came back to the bank to be cashed, and he still enjoyed great banquets with all of his friends. Dali had a magic checkbook.
Isn’t this same scheme employed by the Federal Reserve? Isn’t their scam only good for as long as the “checks” are not cashed? Mr. Bayona adds:
But what would have happened if one day art collectors concluded that Dali’s work really did not capture the essence of surrealism, and therefore that his art was not of great value? If that had happened, every autographed check would have come back to the bank (at least in theory), and Dali would have had to pay up. If Dali had not saved enough money, he would have had to find a job painting houses.
Dali was providing something of value, at least in the minds of the restaurateurs who considered his check more valuable as a work of art than traded in for money. Would Dali’s scheme ultimately have failed? Probably. There were obvious limitations as to how far Dali could employ it. He was limited in the sense that he probably could not utilize it effectively twice in the same restaurant. How many framed objects of checks can be hung in a restaurant as “art.” There is diminishing marginal utility from more of any good. That is likely especially so for framed checks as rare art, all from the same patron.
The point is that Dali’s ability to do this was limited by supply and demand. This same constraint of supply and demand is a limiting factor on the Fed’s ability to continue their scheme, although it may be less obvious. Each dollar suffers from the same diminishing marginal utility as do Dali’s checks. It may be less obvious and take longer, but the same process applies.
Bayona concludes:
Salvador Dali had devised an ingenious method for not paying his bills. Similar stories are told about Pablo Picasso. But the Fed does not produce tangible items that people would rather hold on to, like an original Salvador Dali. The Fed does not produce work or items of value. The Salvador Dali effect, i.e., the ability to prevent checks from being cashed by creating something of real value, does not apply to the Fed. That is why it is good to remind the Fed, and the government, to be careful with the expenditures when partying, just in case the magic checkbook disappears.
There were limiting factors on Salvador Dali’s check-writing. Similar constraints limit the Fed. It is only a question of time before their scheme fails. Perhaps that is the reason why QE is supposedly on its way out.
