Think of the great concluding scenes of some of the most memorable movies of
all time.
"There's no place like home," Judy Garland wistfully exclaims at the end of The
Wizard of Oz; "Rosebud" in Citizen Kane; the camp doctor crying
out "madness" as Alec Guinness gives his life to destroy the bridge he built in The
Bridge on the River Kwai;
Now, after the Federal Reserve interest rate cuts on Wednesday, the conclusion
for a new story is being written. As it happens, we're essentially watching the
end of The Ben Bernanke Story.
For the 11th time in 14 months, more importantly, for the second time in three
weeks, the United States Federal Reserve Bank's Open Markets Committee has
engineered a set of interest rate
cuts, this time twin 50 basis point reductions to 1% on the Federal Funds
Target Rate and 1.25% on the Discount Rate.
There is every reason to believe that the Fed made this month's cuts with the
greatest reluctance. After nine rapid-fire reductions that took the Target Rate
to 2% from 5.25% in just eight months, the Fed had been holding pat from late
April to this month's first cut, the emergency interest rate reduction of
October 8.
Federal Funds at 1% have an enormous historical significance. That was where
former Fed chairman Alan Greenspan took the rate down to for more than a year,
from mid-2003 to June 2004. With the desire by Americans to always find simple
causes and ready scapegoats for complex problems, much blame has been placed on
Greenspan's 1% interest rates of that period in kindling and stoking the real
estate boom and bubble that engendered the current subprime mortgage crisis a
few years later.
As simple explanations go, this one possesses more than a few grains of truth,
and it is infinitely superior to many of the other explanations now bobbing
about in the thick fetid swamp of the punditocracy, such as that which posits
that the whole crisis is the result of American liberals foolishly trying to
put minorities in their own houses.
When Greenspan left office to mostly wide public acclaim and adoration in early
2006, just a few months before the real estate bubble was finally stretched so
thin that it cracked and burst open, one criticism he generally received was
that rates had been kept too low, for too long. Nobody took much notice of it
then, for, at that time, criticizing the huge scads of money being generated by
the real estate bubble was seen as a lot like being the guy who keeps his coat
on at the orgy. Still, many observers opined that, for the future health of the
financial system, rates should never be driven that low again.
But now we're here again, four years after we left these rates, back down at
1%. There is perhaps no other data set more indicative of the failure of the
Greenspan/Bernanke ideology of debt-driven macroeconomic administration,
indeed, of the entire free-market, laissez-faire consensus that has recently so
dominated the ideology of economic management, than this fact.
That ideology only a few years ago proclaimed such an overwhelming practical
superiority at generating prosperity that it represented "the end of history";
it now proves itself so poor at consistently maintaining prosperity that it
seems that every few years or so it must drive rates down so low that it, in
effect, involuntarily seizes the assets of savers and devalues them through
even modest inflation.
Amazingly enough, we come out of this FOMC meeting with reports of even more
possible interest rate cuts. A good number of Fed watchers had predicted more
for Wednesday, forecasting 75 basis point cuts that would have brought the
target rate down below 1%, to 0.75%. These predictions are being brought
forward to the Fed's next meeting, on December 16.
The Fed, in the statement that accompanied Wednesday's cuts, gave every
possible indication that it's not done yet.
The pace of economic
activity appears to have slowed markedly, owing importantly to a decline in
consumer expenditures. Business equipment spending and industrial production
have weakened in recent months, and slowing economic activity in many foreign
economies is damping the prospects for US exports. Moreover, the
intensification of financial market turmoil is likely to exert additional
restraint on spending, partly by further reducing the ability of households and
businesses to obtain credit. …downside risks to growth remain. The Committee
will monitor economic and financial developments carefully and will act as
needed to promote sustainable economic growth and price stability.
As if he had decided to prove the point that, in the words of philosopher
George Santayana, "A fanatic is someone who redoubles his efforts as he loses
sight of his goals," former Fed governor Laurence Meyer says that it won't be
enough to lower the rate to 0.75% or 0.50%, it has to be, and will be, cut to
0.0% next year.
I suppose after that would come punitive interest rates. Maybe the Fed will
subsidize a new program to let the air out of the tires of people who come in
to make a deposit.
The basic problem here is that, at its core, capitalism is a system that wants,
and is supposed to reward, the behavior that these rate cuts are punishing -
thrift, savings and delayed gratification. I very well remember teaching an
economics class in 2003, when depositor interest rates were low. I tried to
impress on the youngsters the importance of savings and thrift, to avoid
running up big credit card bills, to regularly deposit money in the bank.
One raised a hand. "If I deposit $100 in the bank today, when will it double?"
I explained the rule of 72, the economic formula that describes how long it
takes an investment to double with compound interest. The formula is 72 divided
by the interest rate. With interest rates then at 1%, the answer then was
"2075".
The class laughed the laugh of college students who think they know more than
their professor. Maybe they were right.
Of course, dropping rates to 0.75% brings the doubling date up to 2104; 0.50%
rates brings it to 2152. Bring interest rates to zero, and it will take longer
to double an investment than the universe has time remaining.
Japan attempted very low interest rates for about a decade from the mid-90s. It
worked better with them, for, with government pension support still a newer
concept there than in the United States, the savings ethic was much more firmly
established in Japan than in the West. Still, although the low rates might not
have led to a disaster in Japan on the level of a fire breathing Godzilla,
there is little evidence indicating that they did much in the way of spurring
growth.
Once you're under 2% or so, if you haven't spurred growth by then, more cuts
after that probably aren't going to do it either.
Whatever the problems bedeviling the American and world economy today, high
short-term interest rates aren't all that prominent on the list. Today's core
current problem is the wave of deleveraging caused by the credit crisis, as
banks and other financial institutions initiate round after round of shrinking
their loan balance sheets.
The US$250 billion initiative by Treasury Secretary Henry Paulson to take
equity positions in banks and other financial institutions placed no mandates
on the banks to actually make new loans with the government largesse, and the
$500 billion program to buy toxic mortgage securities out of the banks'
portfolios just can't seem to get out of the starting gate.
Every day, reports emerge that everybody who can get to the "lobbyists" page of
the phone book, be it insurance companies, banks that are privately owned, or
auto companies, are lining up to get their snouts in the trough of the bailout
bill's munificence, and the Paulson Treasury is beginning to look foolish as it
just can't seem to decide who to say yes to next.
But the really important thing to remember is not whether bringing the Federal
Funds Target Rate down near zero works to spur growth. It's the failure of the
economic policies so long dominant in America to bring long-term prosperity
that is really seen here.
As the American presidential election of 2008 winds towards its ignominious
denouement, those outside the United States might be amazed, indeed, they may
even think a joke is being played on them, when they hear that the campaign is
now centered on the issue of whether an unlicensed Ohio plumber, who can't or
won't pay his current taxes, will be required to pay extra taxes should his
fantasy of buying his employer's business for well more than it's worth comes
true.
That's the way it's been in America these past few years, under Republicans
such as Ronald Reagan and the Bushes, as well as Democrat Bill Clinton. The
rich are looked after first, through tax, regulatory and consumer protection
policies, and if the middle classes benefit, fine; if not, well, nothing much
can be done about it, for that would be equivalent to the establishment of an
American gulag.
The middle class saw the lifestyles of the rich and famous rapidly accelerating
away from them, and they tried to keep up. That was attempted by leverage,
borrowing their way to the good life, with dot-com stocks at the turn of the
millennium, and real estate these past few years. Both bubbles spectacularly
burst, and, as America looks for a new road to prosperity that might not
necessarily involve more "extraordinary popular delusions" and "madness of
crowds", the saver class must apparently be once more raped while the country
waits.
In recent testimony before Congress, economist Mark Zandi (who, surprisingly,
is an economic advisor to Senator John McCain; the Republican presidential
candidate, apparently does not know he has a flaming Trotskyite on staff)
listed the prospective economic benefits to be accrued from the different
possible policy alternatives to be included in the new fiscal stimulus package
that will be considered after the election; apparently, a repeat of the spring
initiative, which merely sent out big government checks, otherwise known as the
Chinese Pearl River Delta factory employment plan, will not be considered.
What did Zandi say would provide the most assistance to the economy? Enhanced
government food assistance, called "food stamps", after that, more and longer
assistance to unemployed workers. The least-productive initiatives would be
exactly what has most been produced by the Congress and the government, and
what is most advocated and debated in the campaign - dividend and capital gains
tax cuts, corporate tax cuts, and accelerated depreciation for corporate
investment.
Maybe, if government policies had been along these lines in the first place,
people would not have had to borrow their destinies into crazy bubbles just to
live the American dream.
But whatever happens from the latest rate cuts, it certainly means the approach
of the effective end of the Bernanke story. Whether or not he cuts once more in
December, he has, at the very most, two more 50 basis point cuts in him; after
that, all he'll be doing is standing up there behind the podium as either
McCain or Barack Obama's Treasury secretary (which very well may still be
Paulson) assumes the initiative in policy advocacy.
I can see the last scene as the curtain falls on the Ben Bernanke Story,
otherwise know as Gone With the Write Down.
A frantic saver confronts Bernanke. "Oh, Ben, if you lower rates to zero, where
should I go, what shall I do? "
"Frankly, my dear, I don't give a damn."
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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