Still another government price control that is already ruining lives.
“Central bankers are actually central planners,” – William A. Fleckenstein, “Greenspan’s Bubbles,”
“The Federal Reserve is responsible for the boom-bust cycles.” – Ron Paul, “End the Fed”
Economic history is primed to repeat in the nastiest of ways unless the government stops distorting the price of something that we use every day.
Every product, good or service has a price, which is essential to rational decision-making. We use prices every day as vital data that guide us. Without true prices, prices not distorted by government fiat, we would make mistake after mistake. We spend too much money on some things and too little on others. Money, also, has a price. It is called an interest rate. Central banks are often in the habit of distorting rates for the political benefit of governments, whose economic nationalism policies have caused untold misery.
That is why so many critics of central banks have complained that, without a gold standard—suggested by economists Ludwig von Mises and Murray Rothbard—or without some tight controls on money creation—-such as an automatic pilot as advocated by Milton Friedman, which would use a computer to determine the rate of money creation—-it is inevitable that governments end up creating too much money. Monetary policies are ruled by politics. So money supply and interest rates come not from the interpersonal interaction of market forces, but the whims of governments, governments that need to pay for everything from entitlements to empires.
But cheap money, the same as cheap anything else, leads one to overbuy and overproduce. Too much money is a frequent theme of economic history, whether in 18th century France, with the notorious central banker John Law, or the Continental Congress’ over issuance of its paper money in 18th century America, the continental. That led disgusted holders of the de-valued currency to say that it was “not worth a Continental.” It is why the advocates of limited government were generally suspicious of an American central bank. (Jefferson, an ardent anti-militarist, is reputed to have said that a central bank is a greater threat to liberty than a standing army).
Over issuance of money backed by nothing but the promises of governments that come and go ultimately results in economies and markets that blow up. These events have happened several times in my lifetime and I believe they can happen again. That is despite the frequent assurances from the defenders of the central bank that it acts in an apolitical way; that its only goals are to promote healthy growth without excessive inflation.
That sounds impossible; tantamount to saying someone can gobble up cheese cake every night and never put on a pound. Yet the Federal Reserve, since the latest mess some five years ago, has provided the nation with a politically popular yet economic wrongheaded solution—-it creates more and more money so the government is virtually giving away the currency. It is pushing a zero interest rate policy.
Still, virtually zero percent interest rates are to long-term economic policy what junk food is to nutrition—-it tastes great going down, but later comes horrible results. The same as a drug one can’t stop taking, artificially low interest rates initially seem harmless. Cheap money even seems to produce good results in the early stages. However, later often comes disaster.
Let’s us consider the consequences of the policies of our central bank, the Federal Reserve, yesterday and today. The Fed often takes short term actions that are politically popular—who doesn’t want to pay a low price for something, especially to borrow money?—but later tens of millions of people are hurt. When the economy is badly damaged, few seem to remember the cause of the woes President Nixon is remembered for, Watergate and the Vietnam War, not cheap money, wage and price controls. These were policies that caused problems throughout the 1970s. This is a point I will illustrate below. So, given this historical illiteracy, the boom-bust cycle eventually starts all over. And then the only thing we learn from the history of central banks is that….we never learn from history.
For instance, the Federal Reserve, just in time to re-elect President Richard Nixon in 1972, kept interest rates low. It flooded the markets with cash. For a year or so the economy appeared better—just as today when things seem somewhat better but the economy is not booming. However, under Nixon it was Potemkin village economy. Stagflation followed a year later. Here was close to a decade of misery, double-digit inflation, high unemployment and an almost no growth economy. It began when a new Fed chairman, Arthur Burns, was installed by President Nixon with a charge of providing easy money. Money creation was 25 percent faster in 1972, a presidential election year, than in 1971.
“Some economists,” bragged Nixon aide John Ehrlichman, “are oblivious to political reality, but Arthur Burns was every bit as much as a politician as he was an economist.” (One is reminded of Alan Greenspan’s popularity for years with most democrats and republicans as well as fawning mainstream media profiles such as Bob Woodward’s book, “Maestro.” That was a popular book at a time when central banking was wrongly celebrated as having abolished even the possibility of a recession or a depression.)
Later, after the easy money policy was inflicting pain on millions of Americans, Burns would entitle a speech “The Menace of Inflation.” The Nixon/Burns policies failed. Burns would announce in 1974, “Inflationary forces are now rampant in every major industrial nation of the world.” (Central banks overseas then, and today, generally followed the U.S. lead). Burns conceded that “The gravity of our current inflationary problem can hardly be overestimated.” (From his “Reflections of an Economic Policy Maker.”).
Interest rates in the 1970s and early 1980s shot up to over 20 percent. Interest sensitive industries, such as cars and real estate, were decimated. Burns, by the way, blamed the woes on the huge deficits that the president and Congress, controlled by Democrats, were running. The parallels to today are frightening. President Obama and Congress set a record for red ink—-four straight years of trillion dollar deficits (It is comical that the government can now have a deficit of “only” $600 billion or so). And let us not forget the uncounted off-budget red ink for things like Social Security and Medicare, bills that, like it or not, taxpayers will have to fund. These are deficits that lead some economists to claim that the United States is functionally bankrupt.
So are we about to go through another bout of stagflation or some other economic woe?
I hope not. The Fed recently said that is going to continue its expansive policy of buying bonds and injecting liquidity into the economy. Through its Federal Open Market Committee, the central bank recently announced it will continue its “highly accommodative stance of monetary policy” for some time until the economy recovers.
“In particular,” the Fed recently wrote, “the Committee decided to keep the target range for the federal funds at 0 to ¼ percent and currently anticipates that this exceptionally low range for the federal funds will be appropriate at least as long as the unemployment rate remains above 6 ½ percent.” That likely means the zero option will continue for the foreseeable future. However, some now seem to think that with unemployment now at seven percent, at some point in 2014, the Fed will slowly start to move away from easy money policies.
Yet today few would dispute that the Fed holding interest rates artificially low was a major component in the housing and market disasters of 2007-2008. Anna Schwartz, a monetary historian, told the Wall Street Journal that “there never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan has to answer for.”
(Anyone doubting Ms. Schwartz’s wisdom is directed to page 232 of Alan Greenspan’s memoirs, where he reluctantly concedes that the Fed was responsible for the sub-prime failures of 2007, but, amazingly, continues to support the policy: “I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership distort market outcomes,” Greenspan wrote. “But I believed then, as now, that the benefits of broadened home ownership are worth the risk.”
The last part of this statement from Greenspan’s “The Age or Turbulence” is frightening. It means that supporters of the central bank and its giveway money deals are like the Bourbon kings—they have “learned nothing and forgot nothing.”).
So cheap money, as it always does in its beginning stages, appears to produce recovery or even prosperity just as the economy is about to tank. What follows is a depression or maybe a recession or a slow growth economy that seems more in recession than recovery. Whichever form it takes, it means misery for many.
Indeed, for millions of unemployed and underemployed Americans, many of whom voted for President Obama based on the idea that he would provide prosperity, the recession continues in their lives. The consequences of easy money policies, of the bizarre zero percent interest ideas, are many and pose dangers for all of us.
Firstly, how can central bankers know what is the right interest rate any more than Soviet central planners could know what was the correct price for bread or clothing of anything else? That is why, pace economists like John Kenneth Galbraith and Paul Samuelson who eulogized the Soviet Union right up to its demise, central planning can’t adequately feed or clothe nations or know how much money it needs.
Indeed, central bankers playing with money markets are guessing, warns fund manager William Fleckenstein. “Like bureaucratic leaders of central-planned or command economies, they pick an interest rate to within two decimal places that they guess will be the correct one, and then proceed to cram it down the throat of the banking system,” writes Fleckenstein in “Greenspan’s Bubbles.”
Then, if the rate doesn’t reflect market forces, more problems follow. For instance, the United States has some of the lowest savings rates in the developed world. (And ironically, as I write this, President Obama, in his proposed fiscal 2014 budget wants to put a cap on qualified retirement account balances, which include savings vehicles such as IRAs and 401(k)s. Why cap retirement savings vehicles when millions of Americans as well as the nation need to save more? The Obama administration, in the budget message, said that creating and reducing the long-term deficit “depend on a tax system that is fairer, simpler and more efficient than the one we have.”
Americans, for macro and micro-reasons, desperately need to save more. They need to lower the true costs of capital by increasing the capital pool. And millions of Americans need to save for their children’s higher education. (Suggestion: Why not, in the interests of improving a weak economy, simply declare a saving and investment taxes holiday? Then, when that improves saving and capital gains levels, why not abolish these taxes forever? And, by the way, pace advocates of Keynesian policies who insist that the government must continue to consume “to keep the boom going,” isn’t saving, as the Austrian economists tell us, just a form of delayed consumption. It is what Austrians called “a time preference.”).
There are also tens of millions of Americans who need to save for a looming retirement at the same time that it will likely include more cuts in the social insurance programs.
What do I mean more cuts in programs like Medicare and Social Security?
Over the years, the Social Security full payment retirement age has been gradually raised, which reminds one of the superb Joseph Heller war novel “Catch 22.” In the novel the number of missions until a pilot could finally go home was perennially raised just as someone got close to reaching it. Social Security payments—I know this sounds strange to younger readers but it is nevertheless true—once were not taxed. How could you pay tax on something you had paid as a tax for 40 years? That is until President Reagan and a Democratic Congress decided to start taxing the payments in the 1980s.
It is inevitable as these mismanaged social insurance programs. Why do I say mismanaged? The basic problem is the surpluses were spent over the last 20 years instead of saved and now these systems are running in the red—will have higher taxes coming and going. By that I mean recipients and taxpayers will both have to shell out more and ultimately get less than the promised amounts. Indeed, in a sentiment that I expect to hear more of as these programs become desperate for cash to pay retirees, Ronald J. Sider, in his recent book “Fixing the Moral Deficit,” bemoans that “so little” of Social Security payments are now taxed. His solution is to increase taxes on people paying into the system and tax more of the benefits going to retirees.
The perils of rigging the money markets, as the Fed is doing, are many. Zero interest rates are also difficult for retirees who depend on variable rate annuities and bonds for part of their income. Bond and money market yields keep declining because the government is tinkering with interest rates just as New York lawmakers tinker with housing prices through rent control laws. They cause housing shortages and the pricing anomalies in which even the well heeled can get cheap housing (In the “Worst Team Money Could Buy,” a book about the New York Mets in the 1990s, star pitcher David Cone, who made millions of dollars, said he wanted to re-sign with the Mets because he had a beautiful rent-controlled apartment on the swank Upper East Side of Manhattan).
Zero rates also means retirees’ income is lagging if they have a bond heavy portfolio. If they had known seven years ago that the Fed would force and keep rates down, many of retirees would have invested their money differently. After all, the Fed’s recent policies are unprecedentedly low. But there is a bigger problem with zero interest rates. It is one we should all be concerned with, regardless of whether one is retired or not. The Fed, once again, could be creating a bubble as it has several times before.
Many people are now turning to the stock market, not necessarily because they want to or because they like equities, but for another reason. It is one of the few investments in which they have a chance to get a decent return on capital. It is one of the few places that one has the chance of beating persistent implicit and explicit costs that drag down their standards of living: the misunderstood tax, inflation, and the visible taxes we pay every day. But again, the cheap money/stock market option—-what some commentators have called “the Greenspan Put,” an immediate Fed rate cut to pump up the market—is the biggest problem of zero interest rates. Here millions of investors are misled. They come to believe that cash is trash; that bonds are no good and that only stocks matter, which ultimately leads to a crash. It’s happened before.
For example, in the Burns/Nixon cheap money episode discussed above, the stock market eventually crashed in 1973-1974. The market, in an 18-month period, declined by around 40 percent. Billions of dollars in value was lost. The consequences just for those near retirement are terrible. Imagine you had just retired with a lot of stocks in your retirement nest egg just before the crash of 1973-74. All of a sudden, your retirement plan wasn’t secure. You probably had to return to work or reduce your expected retirement lifestyle.
For about a decade, millions of Americans wouldn’t touch stocks. The damage was felt for a long time “For years, I didn’t want to come to work,” I remember an old time stock broker telling me. By the end of the decade, the average investor was so disgusted with the stock market that “Business Week” famously ran a cover story entitled “The Death of Equities.”
If the Fed doesn’t stop rigging the capital markets it could be the death of millions of portfolios, the death of the savings and investment plans of millions of Americans who have depended on a currency that has been abused for the benefit of governments both republican and democrat.
“So let me warn you again,” writes business columnist John Crudele in the April 16, 2013 New York Post, “the only thing this market has going for it is the Federal Reserve’s persistent money printing operation.” He warns that, if someone can’t afford to lose 20 percent in a hurry, the investor should get out as easy money policies will, as they did in the 2007-2008 super storm, destroy trillions of dollars of assets.
Central bankers will blunder again and again. It is the nature of a system designed to blow up every few years. That is unless most Americans, many of whom who would resist the fixing of their wages, call an end to these vicious money cycles of the central bank, with its fixing of the interest rates. They must realize a simple economic truth: The government fixing the price of the price of money is a prescription for disaster.
“The Fed,” says Pace University business professor and monetary historian Joseph Salerno, “should be abolished because its legal monopoly of the money supply renders it an inherently inflationary institution able to create money at will and without limit.”
The logic is indisputable. The warnings of Jeffersonians and other central bank critics over centuries of monetary history should be heeded. The central bank should go.
Gregory Bresiger is a business journalist living in Kew Gardens, New York, who works for the New York Post Sunday business section. His work has appeared in Financial Advisor Magazine, Traders and Mises.com. He is also the author of “Personal Finance for People Who Hate Personal Finance” and the recently published “Money Sense.”