Why both liberals and conservatives should hate the Fed

The Federal Reserve Bank

Most people don’t wake up in the morning thinking about the Federal Reserve System, the nation’s central bank.  Frankly, I don’t either.  But, when I think about it these days, I really hate what they’ve done to our economic prospects. 

Here’s why.

The Fed’s normal tools for modulating the economy – raising or lowering short-term interest rates – have exhausted their usefulness. Lower rates should stimulate the economy by reducing the cost of borrowing. But, when the economy wasn’t growing even with zero interest, what do you do?

Quantitative Easing (QE) was intended to stimulate the economy by supporting the acquisition of financeable assets through a policy of buying bonds like Treasuries and mortgage backed securities.  These purchases on a massive scale created low long-term interest rates with a goal of supporting the acquisition of financeable assets.  And it worked!

So, why do conservatives hate the program?  Because the increased supply of money hasn’t flowed through banks to increase the available capital for businesses to invest in growth.

Many blame the banks.  However, we should remember that we’ve told banks to cease the risky practices that led to the financial crisis.  Through the Dodd-Frank financial reform, we increased oversight of their lending activities. Also, international agreements negotiated in Basel, Switzerland required banks to increase the amount of capital they retain on their balance sheets, thereby decreasing capital available for lending. 

So, we succeeded in making banks less risky but decreased the capital flowing into the economy.  In terms an economist would use, we decreased the velocity of money. 

That’s why conservatives, read business people, hate theFed’s policy.  Growth has been floundering in the 2% range.  Take away the oil and gas boom and it would be closer to 1%.

Meanwhile, liberals -- led by the head cheerleader NY Times columnist Paul Krugman – embraced these policies.  More debt, more money in the economy the better, they said.  As for conservative fears about a collapsing dollar and inflation, we have seen no evidence.  Fools they must be, right?

Well, not exactly.  Sure inflation has been low for the last several years.  However, when viewed next to other currencies, the dollar has been weak.  And, a weak dollar increases the cost of buying foreign products.  In the last year, the Fed has ceased its bond-buying program while Europe and Japan have begun theirs.  Here’s what has happened to the dollar.

Dollar Index -- 5 year chart

What about the other effects of QE? 

The financeable assets that most benefited from the Fed’s policy have been real estate and the stock market.  Coupled with a tax code that rewards asset ownership, the policy has made the rich richer.  Liberal voices have decried income inequality without raising the connection between inequality and the Fed’s policies. 

If you want to find those most hurt by the Fed’s Zero Interest Rate Policy (ZIRP), look no further than savers who rely on interest for their income.  These include not just today’s retirees needing a low risk source of income but future retirees depending upon the success of those managing their pension funds in todays’ financial environment.

Further, policies that undermine business investment reduce employment opportunities, increase income inequality and reduce tax revenue to the government, thereby reducing its ability to fund programs that help those less fortunate. 

But, there is hope.  QE is over and ZIRP may be in its last days. And, as we emerge from a period of unprecedented Fed interference in the market, the government’s deficit has been reduced.  The end of the Bush tax cuts coupled with the cap on government spending pursuant to the budget deal struck by Congress and the President in 2011 have reduced the annual deficit.

Meanwhile, the Boston Consulting Group has projected that the US will be the manufacturing site of choice in the coming years owing to lower energy and transportation costs and favorable labor policies. 

It seems that the lesson here is: keep the government’s capital out of the market and our economy will soar.

WHO WILL LEAD?

A Wedding, a Birthday and American Exceptionalism

Monticello

It’s Thomas Jefferson’s birthday as I write this.  My wife and I just returned from a wonderful long weekend in Charlottesville, VA, the site of Jefferson’s home Monticello which we enjoyed visiting.  The occasion for the trip was not Jefferson’s birthday but rather my cousin’s wedding.

The weather was wonderful and the wedding celebration even more so.  As is often the case, I managed to find my way into an intellectual discussion in the midst of all this celebration.  I enjoy a debate that is respectful and where I have the opportunity to learn something new as was the case on this occasion. Standing a few feet from the Italian buffet, I was discussing American Exceptionalism with a well-traveled and obviously well read woman. 

She decries the use of the term.  Having lived overseas at various times in her life, she connects it to the boorish Ugly American who embarrasses us all.  She is undoubtedly correct in making that connection. Many conservative politicians have used the term to advance the idea that Americans are superior.  I agree with her in that I find Americans to be no more exceptional than citizens of other countries.

The term American Exceptionalism can be traced to the writings of Alexis de Tocqueville and refers to the notion that the United States was born of new ideas -- liberty, equal opportunity and laissez-faire economics.  In that sense, America was and remains exceptional.

Our economic progress has been the result of ideas embraced by both major political parties. Public investment in infrastructure, private investment in free enterprise and openness to immigration have created an economy that generates nearly a quarter of the world’s GDP despite having only 5% of its population. 

So, despite the xenophobia of established citizens and political efforts to slow the influx of immigrants, they keep coming.  The promise of an American way of life is as attractive today as it was in the 19^th and 20^th Centuries.

Our continued prosperity is derived from principles of Economic Freedom – free market capitalism, private property rights, the rule of law and predictable policy.  It’s no surprise that Jefferson’ study has a portrait of John Locke hanging on the wall to this day.  Locke was preeminent in the British Enlightenment of the 1690s.  He promoted then radical ideas that all citizens should be free to enjoy the fruits of their own labor, that innovators should enjoy the profits resulting from their inventions and that capitalism is the prime mover for prosperity. 

And so, even today, America can claim to be exceptional for its adherence to the founders’ principles and for its diversity of thought and culture. 

 

The blessing circle

My cousin and his bride are both Italian Americans raised as Roman Catholics.  Our celebration lasted for three days.  On the last evening, the couple asked for the blessings of their friends and family.  Standing in a loose circle, we were all given the opportunity to offer our words of love to the newlyweds.  The blessings were officiated by a couple that ministers to a Unity Church.  He was raised in a Jewish household and she as a Roman Catholic.  The offerings included special remembrances (some offered in Italian) as well as a Baha’i prayer recited by an Iranian American and a Jewish recitation that preceded the groom breaking a glass followed by a shout of “Mazeltov!” by the assembled congregation.

How’s that for exceptional?

Somewhere Thomas Jefferson was smiling.

WHO WILL LEAD?