Monday, February 22, 2016

Mend the Fed? Be Careful What You Wish For

Republican presidential candidate Donald Trump has accused the Fed of keeping interest rates low at the behest of President Obama. Marco Rubio waffles about Fed overreach that has led to an unhealthy “Fed-centric economy.” Ted Cruz talks about tying monetary policy to the price of gold.

But I wonder if anyone has really thought about what it would mean to reform the Federal Reserve System.

No doubt, the Fed’s zero interest rate policy is all about keeping the government’s debt interest costs down and protecting debtors from the aftermath of the Crash of 2008. But what would it mean to return to a normal interest rate policy?

No doubt the Fed has badly warped the economy, not just in the past few years, but ever since its inception in 1913.

No doubt, all things being equal, it would be best to link the dollar to gold.

But what, really, should we do? And more to the point, what do we dare to do?

We all complain about the Federal Reserve System. But do we really want to do anything about it?

Modern central banking started with the Dutch and their Amsterdam Exchange Bank. It provided the credit that enabled the Dutch to fight and win independence from Spain. Then the Dutch Prince William of Orange invaded Britain in 1688 and within a decade founded the Bank of England and used the British National Debt to conduct a Second Hundred Years War against the French, ending with victory in 1815. But the fact is that the central bank tended to roil the economy badly, since its war finance operations created inflation, and its post-war resumption tended to bankrupt debtors with withering deflation. Even without a central bank, the US Revolutionary and Civil Wars created first ruinous inflation and then bone-jarring deflation.

Our situation is the same, but different. Now the central bank is involved in goosing and/or cooling the economy on the conceit that monetary policy can help moderate the boom-and-bust cycle.

But I suspect that the real role of the central bank today is to smooth over the distortions caused by the huge presence of government operations in the modern big-government economy.

In the old days, the central bank’s credit operations helped the government commandeer the nation’s resources so that it could fight its national wars. That would result in ruinous inflation during the war and ruinous deflation after the war.

But today the central bank’s credit operations are intended to help the government commandeer the nation’s resources so that it can conduct its redistribution operations, from Social Security to mortgage subsidies. This has resulted in a century of inflation punctuated by various financial panics and banking collapses. The Crash of 2008 was caused by the Fed trying to cool the Fannie/Freddie fueled housing bubble of the 2000s. Call it the government’s clumsy right hand trying to correct the errors of its clumsy left hand. But before that was the Savings and Loan collapse, in which the government’s subsidized Savings and Loan lenders collapsed in the 1980s. It was a case of the government’s deflationary policy of the 1980s having to deal with the fallout of its inflationary policy in the 1960s and 1970s.

We are taught to believe that the Fed wisely guides the economy with the predictions of its economic models and economic data. But most likely it is just muddling through, trying to pick up the pieces of the government’s continuing failed interventions in the national economy. And every time we never see the crash coming.

So what are the chances of reforming the Fed so it doesn’t keep interest rates down to reduce the government’s interest payments. or reduce the “Fed-centered” economy, or get back to gold?

I’d say the chances are slim to none. As long as the government is seizing 35 percent of GDP to redistribute to to powerful interests, and using the credit system in all kinds of ways to favor certain interests, it is going to set up inflations and deflations, and crashes, and it will need the power of the printing press get itself out of a jam, by bailing out banks and frequently acting as lender of last resort to prevent a “sudden stop” in the credit system, and using cheap money to "stimulate" the economy.

And we will continue to build up the Chairmen of the Federal Reserve System, from William McChesney Martin to Alan Greenspan to Ben Bernanke to Janet Yellen, as wise financial soothsayers protecting the nation from fearful portents in the financial heavens.

Because the alternative of recognizing that they are all dull political hacks fumbling their way in the dark is too horrible to admit.

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