Knoxville News-Sentinel November 7, 2010
John Maynard Keynes, commenting on the Federal Reserve after World War I, is reported to have called it a body of "startling incompetence."
Well, the current Fed carries on that tradition. After embarking on a policy of remarkable monetary ease, the Fed seems determined to continue that policy despite no indications it has done any good. What that policy has done is to accomplish little. It has pushed short-term interest rates close to zero and has punished savers and those who depend on their savings as a source of income, such as retirees.
It has resulted in dollars being borrowed at low rates and then shifted into countries such as Brazil to earn higher returns. It has relentlessly driven down the value of the dollar.
The low rates are a result of the Fed buying short-term Treasurys to support the dramatic increase in government spending over the past four years. In buying Treasurys from the banks, the Fed has created excess reserves of more than $1 trillion. These excess reserves basically have sat on the banks' balance sheets because of low loan demand by businesses and consumers. As long as the excess reserves are not lent, then no money is created and inflation stays low.
However, when the Fed buys Treasurys directly from the U.S. Treasury - monetizing the national debt - the result is an increase in the money supply and sets the stage for an inflationary recession. At its Open Market Committee meeting last week, the Fed announced it will start buying long-term Treasury bonds directly from the Treasury. The result will be to lower long-term rates to stimulate investment spending by businesses.
The immediate result, however, will be a further drop in the value of the dollar as more dollars are created by the Fed's purchases and an increase in inflation. There is no guarantee that businesses will invest unless the uncertainty about the future is resolved - something that is up to the Obama administration and Congress. Moreover, when the government is interfering in the market, the private sector knows that rates are being actively manipulated and less risks are taken because of increased uncertainty about the future. What rational person or business will make important decisions not knowing about future taxes, costs related to health care and energy policies as well as the ever-increasing costs of regulation?
What is intriguing about the Fed's new policy of buying long-term Treasurys is that I know of no monetary economist that supports this action. Indeed, after having created much of the economic problems through monetary ease in the first place, it now only compounds the problem. The blame lies not just with Chairman Ben Bernanke but with the entire Fed. Bernanke only has one vote on the Open Market Committee along with the other Fed governors and the presidents of the New York Fed and three other reserve banks.
However, to be fair, the presidents of Fed banks in Kansas City, Mo., Dallas, Minneapolis and Philadelphia have expressed opposition, with the Kansas City president calling the new Fed policy a "bargain with the devil."
Maybe the "startling incompetence" just radiates from Washington.
Dr. Harold Black is the James F. Smith Jr. Professor of Finance at the University of Tennessee. He may be reached at email@example.com.
Get Copyright Permissions © 2010, Knoxville News Sentinel Co.
Happy Birthday Frederic Bastiat
1 year ago