What is a Healthy Economy?

Cartoon by Jim Gibson

Your tweenage daughter wants to know when she can start dating guys with beards and motorcycles. Your first reaction is to tell her she can have her way when hell freezes over. But you are smarter than that. You tell her she is free to date whomever she pleases once she shows more maturity. Satisfied she goes back to texting her best friend about when they will meet at the mall.

This approach has great merit. What does it mean to show more maturity? Does it mean that she makes her bed every morning or does it mean that she has saved enough money for retirement? Clearly, any time she comes to you with another reached milestone in maturity, you can tell her she is still deficient and cannot yet date guys with beards and motorcycles.

Where is this heading? Has LSD been into the JD this morning? It sure sounds like it. My point is that this is exactly how the FED is treating us. Mr. Bernanke tells us that the economy is not mature enough yet to let it go out alone without a chaperone (Mr. Bernanke).  But Ben, when will we be mature enough to stand on our own? The answer is – when Ben says you can stand alone. Be good and go to the mall and spend a lot of money. Ask Ben again tomorrow.

When will the economy be strong enough for the Fed to taper? When will it be strong enough for the Fed to remove all that unwanted and unneeded monetary flab from the system?

Macro does not make this question easy to answer because there are so many ways to judge the present and expected future health of an economy. Most of us think the unemployment rate is a great macro indicator but we also know that the unemployment rate can go lower simply because more people give up looking for work. So it is possible that the unemployment rate could go to 6.9% and the Fed would still judge the economy too weak to walk without a cane.

So maybe if the unemployment rate was falling AND employment was growing, that would be good evidence of strength? But what if most of the new jobs were low-wage and/or part-time? What if most of the jobs were in occupations featuring pole dancing? 

What if employment was growing while events abroad portended a weakened China, Brazil, Canada or parts of Europe? What if those and other countries actively depreciate their currencies against the dollar? Wouldn’t we worry about exports and the President’s goal to double exports as our engine of growth and stability?

Or perhaps employment and unemployment are both improving but continued ambiguity about regulation in housing and financial markets leaves housing demand and supply weak. With housing at present depressed levels it would be hard to conclude that the US economy was out of the woods. What if interest rates start rising as employment improves? Won’t we worry about another housing crash?

You should be getting my point. If not, try a little more Soju. The Fed says the economy needs to be out of the woods but there always are and there always will be conflicting signals in the US economy. Business investment could remain weak for quite a while. The consumer has not exactly rebounded. So what really matters is not so much this excuse about the strength of the economy but rather the Fed’s intent.

This might sound blasphemous but whether it is Bernanke or Yellen, the truth is that we have two popular leaders who will always have a tendency to see weakness in the economy and worse yet – will not cherish the long fight for Fed independence and credibility. Without an independent and credible Fed we might as well let the Department of the Treasury spew money from helicopters as the government deems necessary. And of course, that will lead us sooner or later to catastrophe.

Surely I exaggerate? I don’t think so. Government debt is in outer space and on a trajectory to reach the sun. Yet the government has no plan to constrain our nation’s debt. Notice that the current congressional debate has almost nothing to do with future debt issues.We have known since about 1964 that the baby boom generation would bust the budget today and have had almost 60 years to deal with that – yet we are not much better off in 2013 than we were when I was 18 years old. 

What does Congress and national debt have to do with the Fed? This government debt has to be sold each year. The Treasury has been selling roughly a trillion dollars of debt each year. While the economic recovery is reducing that amount, the respite is temporary and the government will continue selling a s---load of debt each year. Someone has to buy it. That’s a lot of US bonds to soak up. To make this avalanche of bonds desirable the markets would ordinarily need to raise interest rates on the debt. While this is wonderful for the bondholder we all know this would be bad for the economy.

So the Fed plows in with its capacity to create infinite waves of money and buys government bonds. A trillion dollars for bonds? No problem. Ben just writes a check. One does not need to be conspiratorial to believe Obama “makes” Bernanke buy those bonds – one can simply believe the Fed is trying to help the economy overcome this giant wake of the government’s incessant and huge demands for credit. Thus the Fed acts “as if” it were a part of the liberal democratic administration.

In doing so, the Fed abdicates its independence and along with that goes its credibility and ability to function. You know why credibility is important. Without credibility your threats as a parent go ignored. Honey – don’t put that screwdriver in the electrical outlet or I will put you in timeout with Dr. Phil. If the kid never gets put in timeout – the chances are she will ignore your directions. Likewise if the Fed puts in a policy designed to reduce interest rates and we all know that the Fed never acts against rising inflation – then it is likely that at some point a policy designed to reduce rates and stimulate the economy will fail. Future attempts to reduce interest rates will raise inflation expectations and will raise, not lower, interest rates. The Fed at that point becomes largely redundant.

The Fed needs to be independent. The Fed needs credibility. The Fed needs to point its boney fingers and forcefully lecture the government about proper fiscal finance. The Fed has to admit that the economy is ready to walk if not run. They will always find some data or some excuse to postpone proper monetary policy so long as they are in denial about proper central banking and its limits in solving all of man’s problems. The Fed can wait but in doing so it risks a jump from the frying pan into a volcano!