Thursday, March 18, 2010

What the Fed’s Mission Ought To Be
  Economics piece by Thomas E. Brewton

Congress should revise its directives to the Fed and abandon liberal-progressives’ secular religious faith that ivory-tower intellectuals are capable of managing the entire economy.

Senator Christopher Dodd’s just released proposals for changing the regulatory role of the Federal Reserve and for reducing the eleven regional Fed banks outside New York City to small, relatively powerless statistical research units revives the question of what the Fed should be doing.

The import of the Senator’s proposals is to remove whatever independence the Fed enjoys and to make it just an office boy for any administration that happens to be in power.  We already suffer too much inflation from the Fed’s profligate money expansion.  Senator Dodd’s proposals will guarantee even more inflation by making resistance to presidential and Congressional political pressure impossible.

Bill Greene’s comments to a recent posting point to my beef with the Fed’s policies.  Presuming to control the level of business activity, prices, and employment by dropping interest rates (i.e., flooding more fiat money into the market), then raising rates (i.e., selling Treasuries and removing fiat money deposits from member banks’ accounts) has been a disaster since 1919, shortly after the Fed’s creation.  Nonetheless, with the exception of Ronald Reagan, all recent presidents have accepted this Keynesian presumption as unquestionable economic gospel.

Even former Fed chairman Alan Greenspan admitted in his recent testimony before Congress that no group of intellectuals, including the Fed board and its Open Markets committee, are able to gather all relevant market information and to make correct calls on a real-time basis.  Spotting an asset bubble, such as the dot-com boom and the housing mortgage fiasco, early enough to take corrective action is too difficult.

There are too many hundreds of millions of independent actions and reactions occurring simultaneously for any human mind(s) to encompass them and to process them.  The Fed implicitly acts as if it were, however, sitting in a sort of airport control tower from which all economic activity is simultaneously visible and precisely controllable.

In fact, all of our economic statistics are estimates that are several weeks or months old.  Most of them are revised once or twice in subsequent months.  Reality is that the Fed is sitting in its metaphorical control tower staring out a window at activity obscured by a blizzard, while its radar is out of commission.

The Fed’s attempts at this impossible feat arise from directives enacted by Congress, itself not known for understanding of economics.  Particularly since the advent of Keynesian macroeconomics, however, the reigning myth has been that slowing business activity and rising unemployment can be remedied simplistically by pumping more and more money into the economy, spending it on anything.  As this has never worked, liberal-progressive Keynesians like Paul Krugman always conclude that the failure resulted from creating too little fiat money.  Even the trillions of deficit dollars that the administration is spending is still too little for Mr. Krugman.

The Fed’s mission should be limited to two tasks.

Its first job ought to be to stabilize the currency so that individual savers and businessmen can make long range plans and long range commitments that produce real jobs.  Stabilizing the currency means also that we the people don’t get robbed by inflation, that more jobs stay at home, and that domestic businesses expand here.  Stabilizing the currency requires paying close attention to commodity prices, particularly gold, using them as a guide to keeping credit availability within narrow limits, so that the dollar’s purchasing power, domestically and internationally, remains as nearly constant as possible.

Second, the Fed’s mission ought to be that of lender-of-last-resort to banks that are basically sound, but victims of temporary credit squeezes.  Note that, were the Fed to support a stable currency, there would be no huge economic bubbles and subsequent deep recessions, because lenders and investors would lack the oceans of low-interest-rate funds to engage in massive speculation and imprudent lending or investing.  There would, therefore, be no need for huge bailouts, TARP programs, and doubling the Fed’s assets by purchasing nearly worthless paper from banks and insurance companies.

In that connection, the Fed should continue to exercise a regulatory role over banks by imposing balance sheet standards and standards of asset quality.  The Fed’s long-held ability to promulgate deposit-to-capital ratios, for example, is important in maintaining banks’ balance sheet quality and in restraining excessive expansion of money via imprudent loans and investments.

Historically the Fed limited its loans to member banks to rediscounting of so-called real bills: loans or acceptances covering short-term (usually 90 days to 6 months) financing of inventories or receivables that would be sold or collected, turning them into cash within that time frame.

In its recent expansion of rules, the Fed has stood ready to lend to banks against anything that could be put up, including the proverbial hot stove in the middle of the Arizona desert.

The underlying principle is that an elite of Keynesian macroeconomists at the Fed Board cannot do a better job of managing the economy than the hundreds of millions of individuals down where the rubber meets the road.

Thomas E. Brewton
http://thomasbrewton.com/

Posted by Thomas E. Brewton on 3/18/10

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