Since the last FOMC meeting in April, economic data have improved. Most recently US payrolls and average hourly earnings have picked up and retail sales have rebounded. Only inflationary pressures have been conspicuously missing. Yet inflation is but one consideration for the Fed. As rescuer of last resort to the economy and the financial system the Fed is now about 7 years into a recovery with all its emergency bail out policies fully deployed. It needs to reset some of these tools in case of another financial or economic crisis. Granted, it also has to do this without precipitating a financial or economic crisis.

The bottom line is that the Fed wants to raise rates. It may not be able to. It has already signalled that it wants to raise rates and it that the path of rate hikes will be gradual. We can see why, the incremental interest expense to each 25 basis point hike (assuming it flows through the rest of the term structure uniformly) will be of the order of tens of billions of USD per annum, not large but not insignificant either.

The Fed has prepared the market for a rate hike for some time and the focus and attention on the next rate hike suggests that the market is prepared for it. What the market may not be prepared for is further delays which could signal a weaker economy than previously thought.

If the Greek’s were hoping for a bailout, their approach to obtaining one is novel. One would have expected a more conciliatory approach. Their current approach suggests that they are unwilling or unable, probably the latter, to comply with the creditors plan. It seems therefore that the choice before the Greeks is austerity in Euros or austerity in Drachmas.

The choice for the creditors is receiving fewer Euros or more Drachmas.

You can’t lend a debtor into solvency. Greece needs to find a long term solution and to do that it needs to decide what it wants to be, not simply what it wants to do. I think that it may be in Greece’s interest to exit the Euro and face the austerity that it will face in any case, in Drachmas, where it will at least have freedom over its monetary policy, although it will be constrained in the international capital markets. As it is, it has no control over monetary policy and it is constrained in the debt markets.

Varoufakis’ game theory experience must advise him that Greece needs to leave the Euro before it is ejected, just as the best strategy for the Eurozone is to eject Greece before it leaves lest other members see exit as painless. The fact is that the pain is not because it is the Eurozone that Greece is leaving but that it is Greece that is leaving the Eurozone. The Eurozone will want to preserve the former myth and the Greeks will probably want to avoid the latter inference. So everyone is served in some way.

The only legitimate complaint the Greeks might have is that the Eurozone suppressed their cost of debt, an analgesic that allowed the country’s deficiencies to persist and accumulate without symptoms for so long. Only the return of country risk in the wake of 2008 awoke the various countries to their conditions as sovereign spreads diverged to reflect individual members’ default risk.

There is some concern that with the internationalization of the RMB and its eventual inclusion in the SDR, that China’s demand for USD and US treasuries will fall. There may be other reasons why China’s demand for USD and US treasuries may fall but the SDR inclusion and RMB internationalization is not a primary concern. China’s decision to hold USD and US treasuries is not determined by the RMBs reserve status. As far as China is concerned, the RMB has reserve status since this is China’s own sovereign currency.

A tighter trade surplus may result in lower demand for treasuries.

I guess central bankers are human too and don’t have a crystal ball. So they don’t know with certainty how the economy will evolve and they have to make decisions which impact the economy in a way that is imprecise. They also have to consider how their actions will impact the economy, in this imprecise way, and how the economy will react, unpredictably, to their actions, as they decide what to do. It is amazing they even bother trying. Its like trying to control a yo yo at the end of a yo yo at the end of a yo yo.

I’d have just decreed that money supply shall be some function of output, and left it at that, being silent about rates, money supply, inflation, output and all of it. If we went back to defining the use of money, and been dogmatic about supplying enough of it to serve those very functions, store of value and transaction enablement, and nothing more, perhaps we’d spend less time trying to second guess central banks in our business and financial investment decisions, believing that central bankers knew what they were doing.

They are just as lost as the rest of us, but far more powerful in affecting the economy in all kinds of unpredictable ways. The wise central banker would quit.

For there to be reform one has to quantify the problem. Under any form of bail out or support, the size of the problem is hidden. That Greece is in the Euro is already an impediment to price discovery and the quantification of the problem. The Greek economy needs to discover its marginal product for all factors and inputs. Inclusion in the Euro means that locally sticky prices perpetuate misallocation and mispricing. Since some prices will always be locally sticky, it is necessary to have an external adjustment. A Drachma is the additional degree of freedom the Greek economy requires. Under a freely floating Drachma, and there will certainly be volatility, the Greeks will be able to determine efficient factor prices, tax rates and calibrate their pensions and social security accordingly.

The immediate levels may not be palatable to the Greeks, especially in the short run, but the alternative, keeping the Euro and inefficient price discovery only leads to failure of Greek markets for inputs and outputs to clear. And this is a long term problem with recurring symptoms.