THE BEAR'S LAIR Assigning the blame By Martin Hutchinson
The Federal Open Market Committee (FOMC) meeting on March 17-18, if it achieved
nothing else, made one thing abundantly clear: even after all the damage that
has been caused to the global economy, the Federal Reserve neither accepts
responsibility for its misdeeds nor has any intention of modifying its errant
behavior. A private sector institution that behaved in this way would be bust -
unless it found a way of wheedling endless billions out of the unfortunate
taxpayers. In monetary policy as in most human activities, there is an urgent
need for accountability.
Only two years ago, Fed chairman Ben Bernanke was proclaiming a "Great
Moderation" by which improved monetary management capability by the Fed and
other central banks had caused a permanent decrease in the volatility of the
global
economy, with inflation remaining low while growth continued at a steady pace.
The only disturbing factor was a mysterious "savings glut" in Asia, which was
causing balance of payments imbalances and might conceivably prevent the
capital markets from accommodating ad infinitum the worthy consumerism of the
US public.
As we now know, this analysis was unadulterated hogwash. Far from producing a
"Great Moderation", the Fed's excessively lax monetary policy over the past
decade has produced the most dangerous global recession since the Great
Depression. Far from being the world's chief problem, the Asian "savings glut"
was the result of uncontrolled US money printing and balance of payments
deficits - and that glut may now be the principal factor allowing the world to
escape the current troubles without repeating the experience of the 1930s.
So where's Bernanke's apology? Or, better still, resignation? Why are we still
being forced to listen to his endless predictions of deflation, something that
has completely failed to appear, either in 2002 when he first predicted it or
in the last few months, during which core inflation has remained resolutely
positive with a tendency to accelerate? Where is the legislation threatening to
tax his income at 90%, in retaliation for his role in causing this disaster?
Where is the investigation of his finances by the New York state attorney
general? Where even is the beautifully modulated denunciation by President
Barack Obama?
The lack of political blowback from the Fed's mistakes is perhaps unsurprising,
but it is also dangerous. The policy-setting FOMC meeting on March 18 voted to
compound the Fed's errors of over-enthusiastic money creation by buying $750
billion more credit-card and mortgage debt, $100 billion more of debt of the
odious and superfluous mortgage guarantors Fannie Mae and Freddie Mac, and $300
billion of Treasury bonds. With broad money supply increasing at an annual rate
of more than 15% even before this latest extravaganza, all hope of monetary
moderation has been lost.
The late Fed chairman William McChesney Martin famously defined the Fed's job
as "taking away the punchbowl just as the party gets going". Under Alan
Greenspan and still more under Bernanke, the Fed "spiked" the monetary punch,
thus producing a very unpleasant hangover. It now proposes to treat that
hangover by injecting absolute alcohol directly into the economy's veins.
The Fannie Mae/Freddie Mac purchases compound an old error; they limit the
scope of the private sector in the mortgage market. That's the mistake that led
to securitization's takeover of that market, a development that can now be seen
to have raised mortgage costs and destabilized housing. The other new debt
purchases, apart from the effect of their huge size on monetary expansion, will
artificially revive the securitization market, providing subsidized competition
to the banking sector. Since the principal economic need in this difficult time
is for the banking sector to earn profits sufficient to fund its past mistakes,
these purchases are economically counterproductive.
However, the most dangerous part of the FOMC's new aggression is its purchase
of Treasury bonds. Already, the Obama administration is promising to run budget
deficits of more than 10% of gross domestic product, far beyond any seen in
previous US peacetime history. The Fed now proposes to monetize those deficits,
reducing their political cost to the crazed public spenders, but greatly
increasing the danger of spiraling inflation.
Funding excessive budget deficits through the central bank was a favorite
tactic of Weimar Germany (until the roof fell in late in 1923), various
Argentine governments and banana republics everywhere. It is one of the most
effective ways known to destroy the economy, since to the normal "crowding out"
effect of excessive state borrowing it adds the wealth-destroying effect of
surplus money creation. In Third World countries whose monetary system has been
competently designed by Western bureaucrats under aid grants, it is illegal.
The FOMC's action was initially popular with the markets, and with
market-oriented commentators. "Grownups in Washington won't let the circus over
ill-gotten corporate bonuses distract them from saving this economy," wrote CBS
MarketWatch.
In reality, what remains of the US private sector appears well on the way to
saving itself. Retail sales were up in January and February, the upward slope
in unemployment claims is becoming less steep and economic statistic after
statistic comes in significantly better than the forecasts, now adjusted to
doom and pessimism.
The main unknown is the true condition of the banking system, but here the main
need is to avoid further government meddling, whether by providing ludicrously
expensive bailouts of bad loans the banks are taking care of themselves, or by
imposing randomly punitive taxes on the unfortunate bankers. It seems
increasingly likely that even Bank of America is working its way out of its
problem, with only Citigroup and the egregiously awful AIG being true basket
cases likely to need yet further infusions of taxpayer money. The healthier
banks such as Wells Fargo and US Bancorp have taken to hurling insults at the
Treasury Department and the Fed, an excellent sign that they are well on the
way to recovery!
Once the economy has touched bottom, around the middle of this year, the
private sector's problems will be well on the way to being solved, and we will
only have to deal with the disasters perpetrated by the public sector in
response. Unfortunately, those disasters seem likely to be far more
economically damaging than the original problem.
The Congressional Budget Office believes that US public debt will increase by
over $7 trillion in the next decade, with the deficit remaining in the $700
billion to $800 billion range throughout. There is no equivalent body auditing
monetary policy, but the inflation statistics themselves will soon tell the
tale of money supply growth run riot. It is thus likely that for several years
we will be forced to continue dealing with the multilayered economic crisis for
which Bernanke and his predecessor Alan Greenspan bear so much of the
responsibility.
Bernanke's term ends next January, and it is to be hoped that President Obama
does not reappoint him, though on current form I hold out little hope that his
successor will be much of an improvement. In any case, the incentives at the
Fed are all wrong. While theoretically the Fed chairman should wish to make the
private economy as strong as possible through prolonged non-inflationary
growth, in practice most of his day-to-day contacts are in the public sector,
and his only report of significance is to the economic illiterates of Congress.
There is a better way. When the great and wise Alexander Hamilton set up the
Bank of the United States, he set it up as a private sector institution. The
Bank of England was also fully private until the post-war Labor government
started nationalizing everything that wasn't nailed down. Technically, parts of
the Fed are also private - the 12 Federal Reserve banks are owned by the
banking system - but its incentives are entirely public-sector and in many
cases counterproductive.
There are thus two possibilities. One would be make the Fed truly independent
of government, and provide a remuneration system whereby members of the FOMC
were properly incentivized to get it right. The Fed's statutes must be written
so that maintenance of sound money is the Fed's preeminent goal, not shared
with politicized matters such as the maintenance of full employment. A contract
could be drafted providing a suitably long-term remuneration incentive, geared
to inflation, economic growth and money supply growth, for the Fed chairman and
for all members of the FOMC while in office. To the extent factors deviated
from their target range (for example, the excessive increase in M3 money supply
from 1995), remuneration would be reduced, with the reduction becoming more
pronounced as the deviation was prolonged.
The other possibility would be to design de novo a purely private sector
central bank, with the board of directors consisting of senior bankers. In
pre-1946 London, this worked well because the bankers with high IQs tended to
work for medium-sized institutions. In the Wall Street of 2007, that would not
have worked - as the unlamented former Treasury secretary Hank Paulson showed,
there are altogether too many confluences of interest between a Goldman Sachs
and the Treasury or the Fed. However, if the behemoths are reined in because of
being "too big to fail" and the brains migrate to medium-sized advisory
institutions, then those institutions would be ideally suited both to provide
governance over the central bank and to provide its top officials.
In either case, the separation between the Fed and the governmental apparatus
must be sharply increased. Such a position, however, will be attainable only
when the media, the public and at least some of the politicians have grasped
one overriding truth: the current unpleasantness is far more the fault of the
Fed than of Wall Street, which simply responded to the perverse incentives
provided by monetary mismanagement.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2009 David W Tice & Associates.)
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