Tuesday, January 29, 2013

The Fed -- Too Little Too Late

What happens when you bring too little too late?  For example, you arrive at the party with only a thimble full of JD. Everyone else has peaked and there you are sober as a judge and all the really cool girls are taken. You might as well retire to the library. You could try to “catch-up” quickly but you know how that will end up. That is the way it is with too little too late. All the good options are gone.

So why do people do this kind of behavior? For one thing, maybe we are clueless. Some of us don’t see a problem or opportunity coming until it runs right into us. Garsh honey, after being married for 28 years I didn’t know you had blue eyes. Anyway, a second reason for coming with too little too late is that you are just basically conservative. You NEVER strike first or fast. You prefer to see how things play out. 

Finally there are those people who assess each problem independently. Sometimes you address the issue quickly – like when your daughter brought home that guy with the really loud motorcycle. Other times you believe a more patient approach is best.
So too little too late can occur for many different reasons. I am thinking about this after Ben Bernanke was quoted last week as saying that while he noticed that his low interest rate policy is creating financial bubbles, he doesn’t see any reason to change his policy. 

His speeches make one pretty sure that important people like Federal Reserve Chairmen are studying problems judiciously and coming to very good decisions. But it is worth wondering out loud whether he is either clueless or inflicted by a habit that ALWAYS waits too long to make the right decision.

A recent report quoted in the press was very critical about Fed Policy in 2007 – faced with a slowdown in the economy, the Fed seemed to be the last one to know that a recession was taking place and needed a boost. Of course just before that the Fed was faced with about-to-explode bubbles in real estate and financial markets and closed it eyes to anything they might do about all this. Inasmuch the Fed went from a policy to stimulate the economy quickly to one that slowed it and then back to a policy to stimulate the economy. Wow – now that is frying pan to the fire kind of stuff. The Fed seemed to be the last one to know that a change in policy was needed.

Of course none of this is new. As inflation built during the 1960s and then early 1970s it seemed to take forever for the Fed to react. By the early 1970s the Fed had to jerk the economy around – so much that they finally had to give up for fear of creating an economic crisis. They admitted failure to control inflation when after being the backbone of the Gold Exchange Standard for almost 30 years, the USA unilaterally backed out of that system. Then Nixon, realizing the Fed could not solve the economic problem talked privately to his own portrait several times and decided to implement Wage and Price Controls. Of course that didn’t work. The main effect of W&P Controls was that a 50 cent candy bar was soon a lot smaller and still cost 50 cents. Apparently the W&P Controls didn’t differentiate between price and price per ounce. Lovers of Baby Ruth bars went into the streets and rioted.

We weren’t finished with inflation – it kept escalating throughout the 1970s – until the Fed finally got serious – after doing too little too late they followed that with too much too late in 1980. Remember the stories of 20% interest rates? Those are not fun stories. It pretty much wrecked us for a while.

This history shows why the Fed ought to be on top of their policies. If Bernanke is seeing bubbles forming then he would do us all a huge favor by taking out a really big and sharp needle and popping those suckers. Do it right now. Why doesn’t he do that? I don’t think he is clueless. I don’t think he needs to study this problem. I think he has a wait and see syndrome. But how much more evidence does he need? Hey mom – I see bear droppings on the front porch. I am scared. Don’t worry honey – there are no bears around here. The Ranger told me so.

Bernanke does not want to upset the applecart. The right policy now is to admit that it is time to end the low interest rate policy. But Bernanke isn't when the bubbles will burst. He doesn't want to do anything to anger investors or bankers right now. We can deal with the aftermath of the bubbles if they ever pop on their own. The Democratic Party is saying the same thing about debt relief. Paul Krugman said we can take care of exploding debt in 2030. The government can be counted on to do too little about bubbles because of politics. 

That is understandable. But the Fed is legally independent of the President and Congress. The Fed does NOT have to support expansionary policy. The Fed is supposedly run by apolitical technocrats. Or did the last financial crisis change that? Has the Fed become a lackey to politicians bent on endless stimulus? I hope not. Too little too late will bring another round of too much too late. And of course another recession. 

9 comments:

  1. Dear LSD. I’m first responding to one of your last items: “Has the Fed become a lackey to politicians bent on endless stimulus?” I would reword that to: “Has the Fed become a lackey to politicians bent on endless SPENDING?” Next I’ll respond to: “The Fed is supposedly run by apolitical technocrats.” It’s academic whether Big Ben is clueless—it’s hard to decide which button/lever to adjust when your vehicle is careening uncontrollably out-of-control toward the edge of the cliff and literally about to go over. Steering left or right, jamming the brakes, or pulling the parachute as you go over cliff won’t matter—and hearing little, soft, purring, seductive voices like pointy-eared Krugman’s saying, “. . . it’s OK . . it’s OK—you’ll have a long time to figgir it out until you hit bottom in 2030.”

    Yes, the Fed is Congress’s lackey. Congress spends money and knows at the end of the day the Fed will bail it out. That’s the way it was intentionally set up in 1911 so that the taxpayer always gets the bill because the Fed simply continues to print money/monetize debt/or firgive debt. Look at the incredibly high number of bank failures since the Fed’s creation despite its mission to control the money supply and preserve the banking system. Reinstate the free market, remove the security fail-safe blanket bankers enjoy and expose them to risk and failure (and prosecution), tighten fractional-reserve banking and capital requirements, and we’d have fewer bank failures—and a more reliable monetary system (assuming D.C.’s regains its fiscal sanity).

    The Fed cannot be apolitical as long as the D.C. (Congress and Treasury)-Wall Street crooks-Fed cabal exists (just look at the revolving door of players from Wall Street, K Street, and Constitution Ave. shuttling between back and forth). There is no smoking gun, but a lot of gun smoke and wink, wink, and nodding going on.

    Big Ben can push all buttons and adjust all levers and pull the parachute emergency cord but Congress’ fecklessness and its refusal to deal with spending and the deficit will only accelerate overshooting the cliff. Printing more moola on the way down—or sucking it back into the moola printing machine won’t help. He knows that’s been done before with dire results: The Fed whip-sawed the money supply before the ’29 crash and ensuing depression.

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  2. The Fed has always been, from its inception, a mechanism to lead the US into a unified world monetary system. The politicians are the lackeys. They gave up their responsibilities to ensure a stable and viable economy to a group of bankers with larceny on their minds. Nothing has changed.

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    1. I don't see it Fuzzy -- a world unified monetary system? Most of the cases of the worst monetary policies came after governments had unsustainable deficits and there was pressure on central banks to monetize them. I blame the politicians for most of it -- and weak central banks for some of it.

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  3. Hi Charles,

    We seem to agree on a lot here -- the Fed is creating dangerous precedents by monetizing the debt. They have done it before and it is a prelude to economic disaster. But your point about 1913 and the purpose of the Fed needs more discussion. Virtually all countries have central banks. Our Fed Reserve Law stipulated that the Fed be largely independent of the executive and legislative bodies. So the design is supposed to protect us from monetization of government debt. While you and I point out plenty of times when the Fed erred it is true that the Fed was successful under several Fed chairs. So it is possible to have a Fed that behaves responsibly and independently and within the roles prescribed by the legislation. In summary, Obama will not appoint a Fed chair that does what we want. So we are in for a bad ride. But that does not in my mind diminish the institution. And I don't know what we would do to replace the Fed...

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  4. Dear LSD. Yes, we can have a lot of discussion about the intent of the 1913 legislation. Yes, the “design” was INTENDED to stabilize the banking system to prevent/minimize failures, but that has been an abject failure given all the failed institutions since—I can provide a list if necessary to underscore that conclusion. Insofar as protecting us from monetization of government debt—huh?—isn’t that precisely what is happening now/has been? Successful under several Fed chairs?—I guess that depends on what success means given the numerous bank failures that have occurred despite substantial “oversight” by the Fed and its minion agencies.

    Before the 1913 creation of the Fed regional and local banks were doing pretty much just fine (without having to rely on taxpayers to bail them if they got into trouble), much to the chagrin of the New York banks that didn’t want the competition, and industry was funding growth from cash flow and retained earnings—thus limiting demand for credit upon which the NY banks depended and made money on. In steps the NY banks, smoozing with their lackey pols, and wow overnight we created an economy fully dependent on credit and debt—much to the delight of the NY banks—and failure fully underwritten against failure because the taxpayer then became the lender of last resort.

    Yer last rhetorical question, “What would be do without Fed . . . ?” As long as we have the fiat-money ATM, fractional-reserve banking, and the taxpayer as last resort we’re stuck with it. A return to a true equity-based monetary system would be too shocking. The Fed wears bovine lipstick very well.

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  5. Dear Charles,

    Yes, we appear to have different criteria for success. Looking at the economic history of the USA since 1913 one is free to interpret according to their own criteria. I see a Fed that has made a lot of mistakes -- clearly in the Great Depression they made things worse rather than better. In my blog I listed the mistakes in the 1960s and 1970s. But looking at economic growth and prosperity that came after the Fed, it is hard for me to to agree that it was an "abject failure." A second point has to do with banks failures. Monetary policy is the main job of the Fed. Bank and financial supervision is shared by the Fed with many other institutions including the Comptroller of the Currency, SEC, Thrift supervision. CUNA, FDIC, and more. The design in 1913 was to have the Fed primarily in charge of monetary policy and less involved with financial regulation. So whatever failures you find in that category are not primarily the result of supervision -- more the result of policies wherein the Fed monetized.

    I am still not sure what system you prefer. Gold standards have failed dramatically. They cannot withstand bad governments that spend too much. Perhaps you want 50 currencies in the 50 states? Perhaps you want wildcat banking where any bank can create its own money? To me the problem is bad fiscal policy. I'd keep the Fed and focus most of my attention on governments that don't care about debt. I am no fan of Bernanke but the real problem is found in the White House and Congress...

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  6. Dear LSD. PART 1. There is some truth to the Fuzzmeister’s allusion to the Fed being a mechanism toward a unified world currency. Not the catalyst, but a mechanism as key other “mechanisms” are already in place, thanks to Bretton Woods giving us the IMF and World Bank, and more recently the U.N. and European Union, with its already unified currency. Clearly, these developments point more toward unification than away, and although there is no smoking gun to validate an unequivocally articulated objective for a unified monetary system, clearly there is a lot of smoke. Consider also the momentum and sentiment for a world tax, particularly on western democratic economies, to “fight” global warming—and more recently a world-wide income tax proposed/instigated by the U.N. It’s creepy, this creeping and surreptitious implication favoring less and weakening financial independence and monetary integrity.

    Which leads me to reply to “Gold standards have failed dramatically.” While you say the Fed itself is not to blame for bank failures but rather bad fiscal policy put forth by the Executive and Legislative—with the Fed an innocent bystander only monetizing those fiscal policies, similarly, the gold standard was not inherently bad or culpable, but rather the countries (as you say) that bought too much and sold too little—ergo trade imbalances—and therefore had to relinquish their gold supplies. Politicians and bankers hated the gold standard because it was beyond their ability to manipulate—the gold standard was a very efficient mechanism but it was also a strict disciplinarian. Ergo, Bretton Woods and Richard Nixon—thanks a lot.

    Keep the Fed but focus on govomits that don’t care about debt? Pointless, since the world govomits operate exclusively on fiat-denominated debt backed only by promises backed (mostly) by the U.S. ATM machine—which is backed by the taxpayer as the lender of last resort. The Euro-zone countries cannot create more money, only the ECB can monetize via more Euros, but those are back by the IMF and World Bank who get most of their funding from the Fed, since the world currency is the U.S. dollar. (The Peoples Bank of China also can create money as I know you know.) Keeping an eye on govomits that don’t care about debt would require infinite eyes in the sky and a really big stick but with no bang. Countries that run amuck with debt, as has been proven time and time again, get bailed out by the IMF, World Bank, and eventually the Fed, who issue fait-backed loans created by selling bonds that are never repaid and eventually forgiven, and the U.S. taxpayers’ dollar get more devalued and the dance continues . . . continues . . . . continues . . . repeats . . . repeats . . . like groundhog day all over again.

    So, the gold standard was dismantled because govomits couldn’t behave and now we have a partial world-central-banking-system in its place, based on fiat and ATMs, to keep govomits from misbehaving or “supervising/bailing out” those that do—to what success . . . is there going to be a satisfactory end-game? Two points start a trend: first the demise of the gold standard, then the “partial world-central-banking-system” that isn’t working . . . and then what will be next step, the synthesis? . . . a full world-central-banking-system ala unified monetary system? Through all the smoke do I detect a third point on the horizon, and end-game to end all games? Where is it going to end, Alfie?

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  7. PART 2. What system do I prefer? Wild-cat banking each with its own currency? Shurely not 50 currencies for 50 states—why emulate Europe’s proven disaster? But, maybe wild-cat banking without a failsafe net against failure ala U.S. taxpayer as the bailer-outer, prosecution for malfeasance, corruption, and loss of bankers’ individual wealth and capital rather than depositors’, etc. Although a return to the gold standard (or similar hard currency) would be painful and would not eliminate or prevent govomits from misbehaving, it would reestablish the integrity of participating countries’ currencies, mitigate the possibilities of inflation and currency devaluation and might facilitate saner world commerce. Maybe it could be a stick with some bang.

    This is why I say the Fed is an abject failure . . . because it is a pawn in a losing game with the U.S. taxpayer the ultimate loser and the bankers and pols (both domestic and international) the winners.

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  8. Dear Charles,

    Lots of good food for thought. Look at it this way. The Fed exists because the government created it through legislation. Each country has alternatives for how to deal with the money creation and bank supervision dimensions. China is but one country that has an "in-house" central bank. The monetary policy is under the thumb of the government. There is nothing in the Constitution or elsewhere that keeps the US government from doing the same thing through a new central banking law. I say this to point out the nature of the cause and the effect. The Fed always serves at the pleasure of the government. It can be independent on a day to day sense -- but ultimately if it does not serve the government's interests, it can be brought under control. The problems we face are the product of poor government decisions. The Fed can try to follow a virtuous path but ultimately it cannot win. As for the IMF and World Bank and other institutions they do not create money in any significant sense. They mostly just try to take it from surplus nations and lend it to debtors. Yes, they are a bit of a safety valve but the governments already can increase fiat money as you say and don't need others help in doing so. If we had a responsible government we would not be having this discussion about the Fed.

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