Page 2 of 5 POWER
WITHOUT CREDIBILITY, Part 1 Bogged down at the
Fed By Henry CK Liu
challenge of the task entrusted to them, their faith-based dogma
nevertheless should remain above question.
That dogma is based on a single-dimensional theology that sound money is the sine
qua non of economic well-being. It is a peculiar ideology given that
central banking as an institution derives its raison d'etre from the
rejection of a rigid gold standard in favor of monetary elasticity. In plain
language, central banking sees as its prime function the management of the
money supply to fit the transactional needs of the economy, instead of fixing
the amount of money in circulation by the
amount of gold held by the money-issuing authority.
Thus central bankers believe in sound money, but not too sound please, lest the
economy should falter. Their mantra is borrowed from the Confessions of
St Augustine: "God, give me chastity and continence - but not just now."
This year , the annual august gathering in August took on special fanfare
as it marked the final appearance of Alan Greenspan as chairman of the Federal
Reserve board of governors. Among the several interrelated options of
controlling the money supply, the Federal Reserve, acting as a fourth branch of
government based on dubious constitutional legitimacy and head of the global
central banking snake based on dollar hegemony, has selected interest rate
policy as the instrument of choice for managing the economy all through the
18-year stewardship of Alan Greenspan, on whom much accolade was showered by
invited participants in the Jackson Hole seminar in anticipation of his
retirement in early 2006.
Greenspan's formula of reducing market regulation by substituting it with
post-crisis intervention is merely buying borrowed extensions of the boom with
amplified severity of the inevitable bust down the road. The Fed is
increasingly reduced by this formula to an irrelevant role of explaining an
anarchic economy rather than directing it towards a rational paradigm. It has
adopted the role of a clean-up crew of otherwise avoidable financial debris
rather than that of a preventive guardian of public financial health.
Greenspan's monetary approach has been when in doubt, ease. This means
injecting more money into the banking system whenever the economy shows signs
of faltering, even if caused by structural imbalances rather than monetary
tightness. For almost two decades, Greenspan has justifiably been in
near-constant doubt about structural balances in the economy, yet his response
to mounting imbalances has invariably been the administration of off-the-shelf
monetary laxative, leading to a serious case of lingering monetary diarrhea
that manifests itself in run-away asset price inflation mistaken for growth.
- the Wizard of Bubbleland, Asia Times Online, September 14, 2005.)
Again, earlier this summer, I repeated my observation:
notwithstanding his denial of responsibility in helping throughout the 1990s to
unleash the equity bubble, had this to say in 2004 in hindsight after the
bubble burst in 2000: "Instead of trying to contain a putative bubble by
drastic actions with largely unpredictable consequences, we chose, as we noted
in our mid-1999 congressional testimony, to focus on policies to mitigate the
fallout when it occurs and, hopefully, ease the transition to the next
By the next expansion, Greenspan meant the next bubble, which manifested itself
in housing. The mitigating policy was a massive injection of liquidity into the
banking system. There is a structural reason why the housing bubble replaced
the high-tech bubble.
Alan Greenspan, who from 1987 to 2006 was chairman of the Board of Governors of
US Federal Reserve - the head of the global central banking snake by virtue of
dollar hegemony - embraced the counterfactual conclusion of Milton Friedman
that monetarist measures by the central bank can perpetuate the boom phase of
the business cycle indefinitely, banishing the bust phase from finance
Going beyond Friedman, Greenspan asserted that a good central bank could
perform a monetary miracle simply by adding liquidity to maintain a booming
financial market by easing at the slightest hint of market correction.
This ignored the fundamental law of finance that if liquidity is exploited to
manipulate excess debt as phantom equity on a global scale, liquidity can act
as a flammable agent to turn a simple localized credit crunch into a systemic
Ben Bernanke, Greenspan's successor at the Fed since February 1, 2006, also
believes that a "good" central banker can make all the difference in banishing
depressions forever, arguing on record in 2000 that, as Friedman claimed, the
1929 stock market crash could have been avoided if the Fed had not dropped the
monetary ball. That belief had been a doctrinal prerequisite for any candidate
up for consideration for the post of top central banker by President George W
Bush. Yet all the Greenspan era proved was that mainstream monetary economists
have been reading the same books and buying the same counterfactual conclusion.
Friedman's "Only money matters" turned out to be a very dangerous slogan.
Both Greenspan and Bernanke had been seduced by the convenience of easy money
and fell into an addiction to it by forgetting that, even according to
Friedman, the role of central banking is to maintain the value of money to
ensure steady, sustainable economic growth, and to moderate cycles of boom and
bust by avoiding destructively big swings in money supply. Friedman called for
a steady increase of the money supply at an annual rate of 3% to achieve a
non-accelerating inflation rate of unemployment (NAIRU) as a solution to
stagflation, when inflation itself causes high unemployment. (See
The Fed Created Serial Bubbles by Policy, June 18, 2009, on the website
of NewDeal20.org, a project of the Franklin and Eleanor Roosevelt Institute.)
Fight fire by throwing sound money out the window
Now in the autumn of 2009, two years after the credit crisis imploded in a
global full fledged financial crisis, as central bankers from around the world
gathered again at their annual August ritual in Jackson Hole, the imperative of
sound money, the key dogma of central banking, is temporarily discarded to the
waste basket in order to bail out the world's financial system, which has
collapsed from excess debt made possible by easy money, with more easy money
from central banks to shift the debt to the public sector.
The justification is the need to first put out the raging fire before arresting
those responsible for arson through a dragnet of regulatory reform. Yet the
Fed's way of fighting the raging fire was to pour on it more oil in the form of
easier money. It is a case of the arsonist performing the role of the fire
fighter, to direct the fire towards innocent victims in the general population
and away from its path towards the few who caused it. Part of the fire has
since burned itself out inside a firebreak built by an expanded Fed balance
sheet, but the fire itself is far from being totally extinguished and is
spreading underground in a classic coal-mine burn that can be expected to
smolder for years.
In this context, the gathering of central bankers at Jackson Hole, Wyoming,
reportedly expressed growing confidence that the worst of the global financial
crisis is over and that a global economic recovery is beginning to take shape.
This is an irresponsibly optimistic assessment that borders on fantasy, by a
powerful fraternity of questionable legitimacy and bankrupt credibility. The
global financial system may be showing signs of zombie-stirring caused by
bailout money from the Fed and other central banks, but the toxic assets that
blight the global economy have not been extinguished and still pose a major
threat to real recovery. The global economy is still in need of intensive care,
with a debt virus that is mutating into a strain stubbornly resistant to
Transferring private debt into public debt
What the Fed has done in the past two years is to transfer massive amounts of
private sector toxic debt to the public sector by "aggressively and
innovatively" expanding the Fed's balance sheet. This approach may require a
decade or more to unwind the massive amount of toxic debt in the system, both
in the private and public sectors, delaying true economic recovery.
The approach adopted by the US Treasury and the Fed to deal with a financial
crisis of unsustainable debt created by excess liquidity is to inject into the
economy more liquidity in the form of new public debt denominated in newly
created money and to channel it to debt-laden institutions to re-inflate a
burst debt-driven asset price bubble.
The US Treasury does not have any power to create money. Its revenue comes
mainly from taxes. But it has the ability to issue sovereign debt with the full
faith and credit of the nation. When the Treasury runs a deficit, it has to
borrow from the credit market, thus crowding out private debt with public debt.
The Fed has the authority to create new money, which it can use to buy Treasury
securities to monetize the public debt. But while the Fed can create new money,
it cannot create wealth, which can only be created by work. Unfortunately, the
Fed's new money has not been going to workers/consumers in the form of rising
wages from full employment to restore fallen consumer demand, but instead has
been going only to debt-infested distressed institutions to allow them to
de-leverage toxic debt.