Fed Chair Bernanke cannot get us out of this economic mess.
As I unpack this assertion, a Market Watch story from St. Louis; a major concession by former Labor Secretary Robert Reich; a not-very-reassuring parallel offered by Paul Krugman; and a telling revelation by David Brooks are offered to set the stage. [The details and links are appended at the very end.]
WHY WE ARE WELL BEYOND THE FED RESCUE POINT
Jay B Gaskill
The liberal economist/columnist Paul Krugman would have us believe that the rampant fiscal irresponsibility if the last four decades can continue and that the task of rescuing the US economy from its dreadful doldrums can still be accomplished by monetary policy and some modest tax increases, mostly on the rich. For Krugman, monetary policy means a whole range of measure, principally quantitative easing and similar measures all of which are means to create more money via fiat. The net effect of free money policies, however cloaked, is to reduce the value of existing US money, including funds parked by willing investors who are waiting for a favorable business startup climate. Dr. Krugman tries to reassure us with the information that poor England carried a similar debt load for 80 backbreaking years!
Robert Reich would remind Krugman that “external” factors like China, Europe and the “world economy” can trump any monetary of fiscal gimmicks available to the current administration. He concedes that by Election Day, November, 2012 - “there's a better-than-even chance that unemployment will be back to 9 percent.”
The head of the St. Louis Federal Reserve Bank, James Bullard, sees a risk that fed interest and money creation policies could touch off too much inflation. “Bullard favors an inflation target. Without one, there is always the possibility the Fed would engineer very high inflation.” [My emphasis –see the endnote.]
And the ever soft-spoken David Brooks reveals his concern with the direction of the current administration: “Bad habits have accumulated. Interest groups have emerged to protect the status quo. The job is to restore old disciplines, strip away decaying structures and reform the welfare state. The country needs a productive midlife crisis. The progressive era is not a model; it is a foil. It provides a contrast and shows us what we really need to do.”
This is Brooksonsian code for - “the leaders of the progressive-liberal coalition (in the Congress and the White House) have brought us to the edge of ruin, and someone else has to take over before it’s too late.”
I submit that David Brooks is our Dmitri Shostakovich, a talented intellectual held captive by the Party Establishment, who has been reduced to speaking to posterity in code. It is a measure of the seriousness of our situation that Mr. Brooks is willing to risk speaking as plainly as he did in the quoted New York Times piece.
The shift from dangerously high sovereign debt to a safer, more manageable level requires the actual elimination of annual federal deficits coupled with robust national economic growth so that the debt level shrinks as a percentage of the GDP. This necessary transition will mark the end of the American era of defined benefit entitlements that are structurally programmed to outgrow the nation’s ability to pay for them; the end of a primarily debt financed consumption-driven economy; and the end of an unfriendly regulatory and political environment for private, profit-making commercial enterprises in favor of a primarily investment-fueled production economy.
Whether we can continue to live in a free, prosperous, growing America depends on whether and how soon we can effect that transition.
The sheer magnitude of the necessary changes cannot be materially reduced by magical actions from the fed. That easy path was once explored by the infamous banana republics[i] that attempted to escape their self-inflicted debt burdens by dramatically increasing the money supply -metaphorically relying on currency printing presses. The result was catastrophic inflation, political destabilization and the collapse of democratic institutions. The sheer size of America’s current sovereign debt and the even more dramatic projected debt increases, driven by in-place entitlement programs, cannot be avoided via monetary policy. The scale is too great.
Even now, monetary policy still actually works to a point - before it fails. Failure is almost always the outcome when monetary measures are overmatched by politically-driven fiscal malpractice.
The current and previous administrations have behaved like a reckless teenage driver who always can count on Dad (the fed) to find new, creative ways to compensate for the consequences of bad driving. Bernanke’s charge, to steer the economy between hyperinflation, deflation and economic collapse, is an insanely difficult exercise.
Think of driving a car on ice while political forces tip the roadway, add unexpected curves and set unrealistic goals. Bernanke was taken some unjustified flak, but I much preferred Alan Greenspan.
The immediate problem is scale.
I’ve thought of myself as a JFK, neo-con, Keynesian, in which fiscal and monetary policy are a well-coordinated ballet - tax reductions as needed, small deficits balanced by small surpluses, a tight rein on inflation, a core belief in free markets, supported, not smothered.
Scale issues have screwed up this ballet.
The monstrous flow of money that inevitably followed the dollar’s role as the international reserve currency, the post WWII recovery of Europe, the truly massive scale of fiscal borrowing and fiat-money financed sovereign debt in the West, and the emergence of the blowtorch Chinese economy have produced a perfect storm for the fed. US monetary policy is more and more being driven by these scale issues into the role of somebody tasked with bailing out a swamped boat in a storm, using only a coffee cup.
Using another metaphor, Bernanke is like a Dad being forced to buy a liability-only policy for his reckless teenage driver with a 1 million dollar deductible…’twould be cheaper to ground the miscreant driver...but that is a task best left to the electorate.
The elephant-in-the-room problem is “moral hazard”.
By the way, I think the term moral hazard itself is a verbal moral hazard. Typically, some management type will call attention to some criminal act, a theft, fraud or embezzlement, skip over the individual moral judgment, and point out that the incentive structure that led to it is a moral hazard. In other words, “we’re not immoral yet but we might at least think about stopping the trend someday.”
You wonder how soon the members of the Weimar culture (Germany’s dithering pre-Nazi government) noticed the moral hazard of printing money to buy faux prosperity. This kind of vaguely amoral thinking is all too common in management and government circles (to the extent that ethical issues are even recognized) and it reduces careful moral analysis to a statistical fog.
Theft is immoral by any means, whether it’s accomplished gradually by trickery or up-front at gun point. [Permit one aside: In my former life of crime, I thought the actual robbers I defended (as a group) were more honest, less neurotic and much better candidates for a tshuvah-driven rehabilitation than the whiny, victim group, but that is another story.]
State-engendered, monetary-driven inflation constitutes the collectivist theft of conserved earnings and reserved assets whenever it reaches that sufficient scale wherein it takes property from the common people more quickly than they can reasonably protect it. As a society, we tolerate am ongoing “low” inflation rate, much as somebody coping with a viral infection tolerates a low grade fever. The Weimar Republic in pre-Nazi Germany allowed inflation to move to an intolerable rate, and the resulting economic and political destabilization paved the way for Hitler.
In the 1940’s a very intelligent group of mostly Canadian Jews, among them Alan Greenspan, hung out in New York for several years with a novelist philosopher named Ayn Rand. He and they formed a moral DNA that included a deep respect for individual human dignity centered in the power of reason, the integrity of volition and the right to property. The fed’s original charge stressed the protection of the value of dollar, the control of inflation and coordination with growth-promoting fiscal policies to the extent they were not inconsistent with the above.
The fed will need to return to its traditional role while the executive branch and the congress need to begin the urgent task of restarting a moribund economy while stopping the deficit machine in its tracks. Raising taxes on profit making enterprises, directly or indirectly, will have the effect of chilling much needed private investments. This leaves us with but one play, and it is manifestly not relying on the fed to create new money: We must and therefore eventually will strip away the noisome barriers and impediments to private investment and commerce that stand in the way of a sustained US economic surge. This is a no brainer, once ideological barriers are discarded…and over time they will be. The resulting boom will be a real one, based on real production increases, generating real profits, real jobs and real revenue to the government.
As it happens, business-friendly technocratic leaders are belatedly beginning to take charge in Europe (noting Mario Monti’s new Italian government). But their task is far more daunting than ours needs to be. Once we understand we are out of magical solutions, there will be no shortage of real ones. All that is missing is fresh, business-savvy leadership in Washington, DC.
Here are the promised links and excerpts from Market Watch, Krugman, et al.
By Greg Robb, MarketWatch Jan 7, 2012
CHICAGO (MarketWatch) — More bond purchases, otherwise known as quantitative easing, are not likely at least in the short term because the economy seems on more solid ground, St. Louis Federal Reserve Bank President James Bullard said Saturday.
The personal consumption expenditure index — the Fed’s favorite inflation target — rose 2.5% for the 12 months ending November.
According to the minutes of the FOMC December meeting, some policymakers were worried that inflation would be too low.
“I am not worried that inflation is going to be too low. Either it will come back toward our longer-run implicit inflation target [of 2.0% or a little less] or there is some risk that it would stay fairly high where it is and not come down too much further,” he said.
Some members of the FOMC expressed concern inflation would be too low this year, according to the minutes of the December 13 meeting.
Bullard said in an interview earlier in the week that the Fed is close to setting an explicit inflation target.
This would come in a statement of the Fed’s long-run policy goals that will be under review at the Fed’s next meeting later this month.
Bullard favors an inflation target. Without one, there is always the possibility the Fed would engineer very high inflation.
Chances are the economy won't be in great shape in the months leading up to election day. If the European debt crisis worsens, and if China's economy continues to slow, there's a better-than-even chance that unemployment will be back to 9 percent.
On the other hand, the administration has had a string of foreign policy successes…
Robert Reich in the San Francisco Chronicle magazine, Insight.
Now, the fact that federal debt isn’t at all like a mortgage on America’s future doesn’t mean that the debt is harmless. Taxes must be levied to pay the interest, and you don’t have to be a right-wing ideologue to concede that taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion. But these costs are a lot less dramatic than the analogy with an overindebted family might suggest.
And that’s why nations with stable, responsible governments — that is, governments that are willing to impose modestly higher taxes when the situation warrants it — have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. Britain, in particular, has had debt exceeding 100 percent of G.D.P. for 81 of the last 170 years.
Paul Krugman in the New York Times
One hundred years ago, we had libertarian economics but conservative values. Today we have oligarchic economics and libertarian moral values — a bad combination.
In sum, in the progressive era, the country was young and vibrant. The job was to impose economic order. Today, the country is middle-aged but self-indulgent. Bad habits have accumulated. Interest groups have emerged to protect the status quo. The job is to restore old disciplines, strip away decaying structures and reform the welfare state. The country needs a productive midlife crisis.
The progressive era is not a model; it is a foil. It provides a contrast and shows us what we really need to do.
David Brooks in the New York Times
[i] The hyperinflation episodes in Argentina, Bolivia, Brazil, Chile & Peru in the 1980’s, not to mention Germany (Weimar) 1920-1923, provide us with a sobering reminder: Political destabilization follows hyperinflation and dictatorships follow destabilization as predictably as the night follows the sunset. Just how close to that scenario we Americans willing to go?