Sunday, November 30, 2008
Another Take on the Fed
Thus far, I have given the argument that the FED is in the process of printing money, "pushing on the string" to get the economy going again, but that the money isn't being lent out and is therefore not "stimulating" the economy in proper Keynesian fashion. But what if this were not the case? I've been watching and involved in a few web discussions, notably on Gary North's site, which suggest this might not be the whole picture. In the previous post, I linked to an article which takes a look at political motives and what is going on behind the scenes with respect to the "powers that be." These are the facts as we know them: the FED has bought a very large quantity of assets under the TARP program (Troubled Asset Recovery Program), which has resulted in the creation of a large amount of money, as is showing up in the AMB. However, this money is not leaving the central bank, and therefore cannot be multiplied by the fractional reserve system and drive up prices in the marketplace. Part of this may indeed be due to fears of default and the other motives I have elaborated on in the past ("pushing on a string.") However, I have not mentioned that the FED is now paying interest on money held on deposit with the central bank, which has to motivate the banks to keep money there "earning" risk free interest, at least compared to having no interest payed on their reserves. How much is this rate? We don't know. We also don't know if the deposit is actually "profitable," in that it earns more interest than the interest the bank is paying out for holding that same money (to depositors and lenders, etc.) We also don't know exactly what is going on in the power struggle between the Federal Reserve, the Treasury, and other branches of government. We do know that both have taken very unusual actions of late, and that there have been questions about whether or not those actions are within the powers of these two organizations. We do not know the details of the deals these organizations have made with the banks for saving their sorry butts, although we do know that the banks are acceding to increased government regulation in their activities, as, for example, the last remaining investment banks like Goldman Sachs converted themselves into commercial banks, placing themselves under the same regulatory scheme the others fall under. The era of gunslinger capitalism in the US is over. The fact is, if that money EVER hits the marketplace, it will result in a level of inflation never before experienced by the United States. It APPEARS that the FED is very cognizant of this, and is taking pains to prevent that money from leaking out until it can find something to do with it. What could it do? A number of things. It could raise the reserve requirement, reducing the multiplying power of the fractional reserve banking system and keeping credit expansion in check. It could forcibly re-sell the assets it has bought, retiring money back into the central bank from the market. It could make up something entirely new, as it has for the previous few months. Another sign pointing in this direction, and away from the mass-inflation scenario, is the character of the men themselves, and Ben Bernanke in particular. Despite his "helicopter" comments during hearings before the senate, Ben Bernanke has been unusually tight as FED chairman thus far through his tenure. The media tends to focus on interest rate cuts, and Bernanke has cut the rate quite far, but they overlook the fact that the FED has actually had to put very little new money into markets to achieve those "rate cuts." The FED acted more as an observer than an actor under his direction, at least up until the crisis hit. On top of this, Obama has chosen Paul Volcker to head up his economic recovery team. Volcker is well-known as the inflation hawk who raised rates sky-high in the early '80's, causing severe recession, but bringing inflation under control, at least in comparison to the late '70's. Whatever their meddlesomeness, at this point neither seems to favor expansive monetary policies the way Alan Greenspan did. So what we are left with is the same old Keynesian choice: inflation or recession? Or in this case, inflation or depression? Standard politics of course favors inflation, as that has clearly been the choice of governments using a fiat money system (unbacked paper money) since the beginning of time. The problem is that this time around, thanks to the massive levels of debt we are talking about, the choice of inflation actually presents an existential threat to the dollar, and by extension, the US government itself. I do not think it is a stretch to say this. It appears that the government understands this, and is not bent on suicide. Governments usually want to expand. Its contraction that's difficult, and suicide pretty much never. They usually have to be taken down by very angry folks with torches and pitchforks. However, the political actors themselves will not want to face an angry electorate in a few years, so it is not necessarily an easy call. Could we then be looking at deflation? Probably not, at least not at levels seen in the early stages of the Great Depression, and not for long if it does happen. Nevertheless, it remains that if inflation is not chosen, it appears that the depressive effect could be very, very severe. If we do not see inflation, it is very possible that the country could be moving, ironically, to an economic model more similar to China's: you can mostly do what you want, but you WILL follow the government's orders if/when they decide to interfere. A great deal of lending may become politically driven as the government exercises its new control over the banking industry, in addition to the now politically driven tax and regulatory code. On top of this, our system will already have a lot more built-in red tape. So basically, we may be looking at moving more toward a quasi-fascist system, not unlike the systems of other countries. In fact, many of the changes I have named (interest on central bank deposits, politically driven lending, etc.) already occur in most other places. Sadly, that's probably the best we can hope for. The other alternative is death through inflation. As in other systems with such price regulation and government meddling, growth will be warped and stagnant, and markets inefficient. Command economies simply do not perform as well as open ones. The American dream will officially be over. That is, if we are lucky. A sad observation has occurred to me as I have written many of these posts: how very little of my "economics" posts are actually directed towards actual economics. Mostly, they are discussions of tax law, accounting, corrupt and unnecessarily convoluted banking practices, politics, and the like. This is not economics, this is a game of "guess what the tyrant will do next?" Maybe its time to consider the possibility that economics is dead.