Keeping the Party Going like Michael Jackson’s Doctor

Having tried and failed to effectively “goose” the United States (US) economy, Ben Bernanke (in my vernacular, Dr. BenJammin), decided a longer term approach was needed. Last month, rather than another shot from the Fed defibrillator (QE3)[i], Bernanke, was hoping that his patient would stabilize with a predicable IV drip of the narcotic, “low cost money”. This week a Federal Reserve statement, in addition to Operation Twist reiterated (again) that it was the Congressional lawmakers’ irresponsible behavior which has brought this economy to the brink; and unless something is changed – the result could be calamitous. It seemed as if the Fed was delivering a “we have done all we can and it does not look good” post operation speech. While Dr. Bernanke and his staff were correct (in their diagnosis of Fiscal Crack Addiction), what culpability does the Fed have in this under-performing economy?

Since its inception, the prime directive to the Fed has been to foster steady growth, low unemployment[ii] and predictable pricing in the US economy. With stagnant growth, high unemployment, and the sliding dollar, one might question Bernanke’s effectiveness. After all, Alan Greenspan, the previous head of the Federal Reserve, was hailed by Bob Woodward (2000) as the Maestro. So, shouldn’t President Obama just sack Bernanke, throw himself on Greenspan’s doorstep, and beg him to come back? Is the problem with Bernanke, who is doing something wrong? Or, is there some other reason that the Fed isn’t achieving its goals?

Assuming that Dr. BenJammin is not suffering from a version of Munchhausen by Proxy, this manipulation of the money markets is part and parcel of the genuine belief that the Fed could predicatively and effectively micromanage a free market economy. With his usual cadre of tools impotent, Bernanke’s changes to the Discount Window did not seem to create much controversy, but the Fed’s Quantitative Easing (QE1 & QE2) did. In the most recent Republican Presidential debate, Newt Gingrich said he would fire Bernanke and David Tice (2011) of Prudent Bear Securities charged that this type of financing smacked of a “Ponzi” scheme – borrowing more to cover the borrowing.[iii] Others likened his actions to treason and called for a rescinding of the Federal Reserve Act. Arguably, Bernanke was exceeding his authority when the Fed bought up troubled assets of financial institutions, as well as commercial paper (QE). However, as often is the case, projecting what would have happened is good sport, but undoubtedly, the Fed would contend that if the central bank had done nothing, the situation would have been cataclysmic.

With fiscal policy and regulation draining the resources of the US economy (Coleman, 2011) and the monetary policy trying to juice it up, should we be surprised that our economy is acting like a candidate for drug rehabilitation? Perhaps the question should be, are the current issues of US economy endemic to a free market economy or symptomatic of other issues? Stated differently, is our metabolic syndrome (combination of maladies) a naturally occurring illness or something that we are inflicting on ourselves? To better understand the situation, I found an account of the recessions occurring in the US since 1970 and the possible causes. According to Texas Christian University’s Dr. John T. Harvey, the US economy has experienced six recessions since 1970 and provides his students with the likely causes:

The Stop-Go Recession (1970), caused by increased interest rates (2.5 points since 1960).

Oil Shock Recession (1973-1975), caused by contractionary monetary policy throughout 1973.

Oil Shock II (1980), caused by tight monetary policy in the form of double digit federal funds rate.

The Volcker Recession (1981-1982), caused continued tight monetary policy which led to historically high interest rates, causing large declines in investment and consumer durable goods purchases.

Desert Storm Recession (1990-1991), caused by a fall in investment and consumer durable goods spending – (the orthodox view was the earlier monetary tightening as the cause).

September 11 Recession (2001), caused by technology revolution subsiding and fiscal policy contractions – (the orthodox view was the earlier monetary tightening in response to inflation was the cause).

Sub-Prime Recession (2007-2009), caused by the mortgage defaults and tightening of the credit markets and collapse of economic activity – (orthodox view was that excesses in government spending and debt, and consumption finally led to a downturn) (p 1).

Notice how closely tied monetary policy is to the recessions. Likely the critics of the Fed would say this statement does not go far enough in blaming the Fed for the convulsions of the US economy. Ron Paul (2010), ignored and ridiculed by mainstream and liberal economists, suggested that it was the Fed which was responsible for the devaluation of the dollar, the big swings in the real estate and the flushes in the stock markets. Since there is very little argument from economists that the actions of the Fed, at least in part, contributed to the severity and length of the Great Depression, is it not too farfetched to think that our modern money policy has contributed to the Great Recession[iv].

At a Federal Reserve Conference for college educators, just after the mortgage meltdown, I asked the Dallas President, Richard Fischer[v] “Would the mortgage crisis have occurred in a free market?” The implication of this question was that the artificial markets created by Fannie Mae and Freddie Mac (both created by the Congress and put on steroids at the insistence of Barney Frank and Chris Dodd), were at the root of this crisis. His answer to this question was that the whole situation was very complicated and no one factor could be isolated. Translated, you are just too simple-minded to understand how complicated this all is. Probably so, but perhaps some of his reluctance to answer was the due to the possibility that the FED had as much to do with the meltdown, as did Barney and Chris.

While the Fed has feverishly tried to kill any chance of deflation, there are logical consequences of an inflationary regiment. Instead of allowing markets to regulate prices and market activity, the Fed has chosen an inflationary protocol to artificially stimulate and then try to pull back with higher interest rates. (This reminds me of an advertisement for Viagra™ and a four hour erection requiring immediate medical attention). In addition to losing the benefit of flexible pricing, it seems as if increased prices have created an ever-increasing need for cost of living adjustments, and the demands for higher wages. The American Association of Retired Persons (AARP) estimates that 1 in 10 people over 55 are living below the poverty line (as cited by Foss). Likely, it is no coincidence that fifteen percent of retirees, have had to re-enter the work force or remain working longer than planned (Cahill, 2010). In addition, this congestion of the workforce would logically exacerbate unemployment for younger generations as well.

Perhaps a simplistic view, but when the growth of the money supply exceeds increased production – prices are going to go up. Actually, prices have been going up. Not just in the last few years: “since 1971, the dollar has lost 83 percent of its purchasing power and continues to be debased by the actions of the Federal Reserve,” (Gold Standard Now). If we were to go back to the basics of Monetarist Economics (accepting a national bank is a given), setting the money supply on a predictable growth pattern (tied to the potential growth of the economy) would allow the economy to grow without inflation. Markets would set the price of money based on supply and demand and yes, undiluted risk. Since Dr. BenJammin has announced that the Fed will hold its rates (albeit, below what the market would likely charge), maybe he has gone back to his roots in monetary theory. Perhaps he has figured out that constantly trying to micro-manage the interest rates via the economy’s intravenous drip, is causing the crashes that are sure to come after a euphoric high. Intuitively, the Fed’s bias toward maintaining a controlled inflation rate over the course of almost four decades has been at least part of the problem.

Seemingly, juiced up on stimulants from one side (monetary policy) and drained of blood from the other (government regulation), the US economy appears scared, exhausted and on the verge of going catatonic. Arguably, the US downturn can be directly correlated with the Fed’s chronic diddling with interest rates and inflation of the money supply, but when all is said and done, this predicament metastasized with very bad fiscal behavior. The good news is that this could turn around very fast, but it will take a fiscally conservative leader and a like minded Congress (or one that is scared of being thrown out of office). The irony is that Dr. BenJammin appears to have finally arrived at the only prescription that might cause the US business climate to gain footing – stop making things worse. What would it take for the White House to figure this out?

Cahill, K., Giandrea, M. & Quinn, J. (2011, June 21). Re-entering the labor force after retirement. Bureau of Labor Statistics . Retrieved from http://www.bls.gov/opub/mlr/2011/06/art2full.pdf

Censky, A. Fed dissenters speak out. (Aug 17, 2011). CNN Money http://money.cnn.com/2011/08/17/news/economy/federal_reserve_dissent/index.htm

Coleman, D. (2011). An improved rationale for public choice. Germany: VDM Publishing House.

Foss, B. (nd). Back to work- Seniors confront the need to return to the workforce. Associated Press. Retrieved from http://www.jobbankusa.com/News/Employment/employ70604a.html

Gold Standard Now (NA). (August 15, 2011). America needs a gold standard now. http://www.thegoldstandardnow.org/press-releases/654-america-needs-a-gold-standard

Harvey, J. (2011). John T. Harvey and his exciting courses. TCU Faculty Pages. Retrieved from http://www.econ.tcu.edu/harvey/50453/recessions.pdf

Isodore, C. (June 28, 2011). Fed set to buy $300B more treasuries. CNN Money. http://money.cnn.com/2011/06/28/news/economy/federal_reserve_purchases/index.htm

Paul, R. (2010). End the Fed. New York: Hatchette Book Group.

Woodward, B. (2000). Maestro: Greenspan’s Fed and the American boom. New York: Simon and Schuester.

[i] Bernanke said in a speech that Quantitative Easing was not an accurate term for what the Fed was doing.

[ii] Bernanke tried to have the unemployment goal removed

[iii] Worth noting is the Fed still has more than 1 trillion dollars in mortgage backed securities debt issued by the government sponsored firms Fannie Mae and Freddie Mac, and other long term bonds (Isodore, 2011).

[iv] Great Recession is a misnomer if you consider the late 70’s and early 80’s (Coleman, 2011).

[v] One of the public dissenters to Bernanke’s recent announcements for long term commitments by the Fed and perhaps creating enough separation from Bernanke to take over in case Obama does decide to through Bernanke under the bus.


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