If the Fed ever becomes realistic about the nature of the real-world economy, it will abandon the Keynesian pretension that expansion of the money supply has the same effect as real savings by businesses and individuals.
Thomas E. Brewton
Establishment of the Federal Reserve System in 1913 enabled arbitrary and excessive inflation of the monetary base supplied to banks and other financial institutions. In every recession since 1913, especially the 1930s Depression and our current housing and subprime mortgage bust, Fed action made bubbles larger and more pervasive and made subsequent buble-bursts more devastating than they would have been otherwise.
Over a short six-year period preceding the Great Depression of the 1930s, the Fed doubled the lendable deposits of the nation’s banks. Other over-expansions of the money supply also led to the unprecedented inflation and high unemployment of the 1970s stagflation, to the 1990s dot.com boom-and-bust, and to the current collapse of housing and financial markets.
The historical facts are available. All economic bubbles are preceded by and inflated by the presence of too much money at unrealistically low interest rates. When credit is so readily available, at such low interest rates that anyone, even with a bad credit rating, can obtain a loan or a credit card, it’s clear that banks have much money than can be absorbed by sound borrowers with legitimate needs. Under the impetus of the Fed’s cheap money expansions, financial institutions have to lower credit standards to find enough borrowers to utilize their inflated lending capacities.
During the dot.com boom, companies in the planning stage, before recording a single dollar of sales, were able to secure one or two billion dollars of institutional venture capital. During the recent housing boom, anybody could obtain a mortgage loan regardless of his capacity to handle the debt service requirements. To absorb the endless torrent of money coming from the Fed’s Open Markets desk, Wall Street computer jockeys conjured up ever more complex and larger packages of individual mortgages to tap all sectors of institutional capital markets.
Chairman Bernanke and the majority of Federal Reserve officials appear to be oblivious to what was happening.
A main reason, one suspects, is that accepting reality would lessen their powerful role as managers of the whole economy. What’s the point of being regarded as expert managers if you can’t regulate everyone else’s life? Simply stabilizing the rate of money supply growth is evidently a role beneath their intellectual pretensions.
Today’s Wall Street Journal reports:
Fed officials used to think there was little they could or should do to prevent bubbles from inflating. For one thing, identifying bubbles with any certainty was deemed to be too difficult. And even if they could be accurately pinpointed, pricking them might do more harm than good. Raising interest rates to stop a bubble, for instance, could slow growth in other parts of the economy that were otherwise healthy.
The Fed’s main strategy instead was to mop up after a bubble burst with lower interest rates to cushion the blow to the economy and restart growth. That strategy was a key conclusion of Mr. Bernanke’s writings on the subject of bubbles when he was a Princeton professor, and again when he first came to the Fed as a governor in 2002. It was an approach embraced by his predecessor Alan Greenspan.
Now, Fed officials admit the stance didn’t work...Mr. Bernanke falls on the side of greater regulation, an idea he has advocated in the past.
“The best approach here if at all possible is to use supervisory and regulatory methods to restrain undue risk-taking and to make sure the system is resilient in case an asset price bubble bursts in the future,” Mr. Bernanke said in answer to a question after a speech in New York last month.
Translation: keep giving excessive amounts of money to banks, but empower the Fed to substitute its judgement for bank credit committees. Don’t take a pyromaniac’s matches away from him, but decide which buildings he can set ablaze. To deal with an alcoholic’s binges, give him more booze, but restrict the locations in which he can drink.
Federal Reserve thinking, exemplified by Mr. Bernanke, is a version of closing the barn door after the horse is gone. There is no need to recognize a bubble while it’s inflating. Just don’t blow air into it, and there will be no ballooning bubble in the first place. Don’t try to manage the economy by fine-tuning interest rates, a process that involves artificially and arbitrarily manipulating the money supply.
The Fed, since the Employment Act of 1946, has viewed its role as working with the Federal government to maintain full employment. That is an illusionary goal that leads to continuous inflation of prices and recurring bubble bursts that worsen unemployment. Even the 2%, plus or minus, that the Fed considers an acceptable rate of inflation will raise the cost of living more than 60% in a 25-year working life. Most people’s incomes don’t increase that fast, year after year.
Inflation is really a tax that falls most heavily on the lower and middle income segments of the population. The purchasing power of lifetime savings erodes continuously as the cost of living continues to climb. But, because inflation always and everywhere is a function of too much money, the highest income brackets, especially Wall Street investment bankers, thrive mightily. Excess money and low interest rates boom the stock market, at least in the early phase of a Fed money gusher. With the Fed pumping a torrent of excess money into the system, thereby driving interest rates below a real market level, financial institutions can grow their business at a pace far in excess of underlying real economic growth.
Money and price inflation engineered by the Fed, not free-market capitalism, is the source of the multi-million dollar bonuses that produce the widening gap between middle-class income and the top earners, the gap that so inflames Democrat/Socialist politicians and mainstream liberal-progressive media such as the New York Times.
If the Fed ever becomes realistic about the nature of the real-world economy, it will abandon the Keynesian pretension that expansion of the money supply has the same effect as real savings by businesses and individuals. It will acknowledge that its repeated over-expansion of the money supply is the genesis of boom exuberance and the economic collapses that always ensue. It will simply foreswear creating bubbles, rather than attempting to manage them.
