The Fed’s Contradiction (and ours)


From the WSJ:

Easier money hasn’t led to more growth, so we need still easier money.

Four years ago this month the Federal Reserve began its epic program of monetary easing to rescue an economy in recession. On Wednesday, Chairman Ben Bernanke declared that this has worked so well that the Fed must keep easing money for as long as anyone can predict in order to save a still-sputtering recovery.

That’s the contradiction at the heart of the Fed’s latest foray into “unconventional policy,” which is a euphemism for finding new ways to print money: The economy needs more monetary stimulus because it is still too weak despite four years of previous and historic amounts of monetary stimulus. In the words of the immortal “Saturday Night Live” skit: We need “more cowbell.”

In his press conference Wednesday, Mr. Bernanke was at pains to say this week’s decisions were nothing new, merely an implementation of the policy direction that the Fed’s Open Market Committee had set in September. This is technically true, but the timing and extent of the implementation are more than details.

The Fed committed Wednesday to purchase an additional $45 billion in long-term Treasury securities each month well into 2013, in addition to the $40 billion in mortgage assets it is already buying each month. At $85 billion a month, the Fed’s balance sheet will thus keep growing from its current $2.9 trillion, heading toward $4 trillion by the end of the year. Four years ago it was less than $1 trillion.

The Fed’s goal is to push down long-term interest rates even lower than they are, to the extent that’s possible when the 10-year Treasury note is trading at 1.7%. The theory goes that this will in turn reduce already very low mortgage rates, which will help spur a housing recovery, which will lead the economy out of its despond. This has also been the theory for the last four years.

In case there was any doubt about its resolve, the Fed statement also issued a new implicit annual inflation target: 2.5%. The official target is still 2%. But the Open Market Committee stated that it will keep interest rates near zero, and by implication keep buying bonds, as long as the jobless rate stays above 6.5% and inflation stays “no more than a half-percentage point above the Committee’s 2-percent longer-run goal.”

That is a 2.5% inflation target by any other name, and it’s striking to see a central bank in the post-Paul Volcker era say overtly that it wants more inflation. This is a victory for the Fed’s dovish William Dudley-Janet Yellen faction that echoes economists who think we have to inflate our way out of the debt crisis. Inflation remains quiescent, but central banks that ask for more inflation invariably get it.

These new overt economic targets are part of Mr. Bernanke’s campaign for more “transparency” in monetary policy, but they also have the effect of exposing how much the Fed has misjudged the economy. In January 2012, the Board of Governors and regional bank presidents predicted growth this year in the range of 2.2%-2.7%. On Wednesday, they predicted growth of 1.7%-1.8%, which means they are expecting a downbeat fourth quarter.

Which brings up another irony: Mr. Bernanke may be pulling the trigger on more bond purchases now because he fears economic damage from consumer and business concern over the fiscal cliff. Yet no one has done more to promote public and market worry over the fiscal cliff than Mr. Bernanke, notably in his June testimony to Congress.

Meantime, the Fed’s near-zero interest rate policy will continue to disguise the real cost of government borrowing. One reason the Obama Administration can keep running trillion-dollar deficits is because it can borrow the money at bargain rates. Stanford economist and Journal contributor John Taylor says the Fed has bought more than 70% of new Treasury debt issuance this year.

All of this will create a fiscal cliff of its own when interest rates start to rise. The Congressional Budget Office says that every 100 basis-point increase in interest rates adds about $100 billion a year to government borrowing costs. Pity the President and Congress who have to refinance $15 trillion in debt at 6%. If Mr. Bernanke really wants to drive the President and Congress to reduce future spending, he shouldn’t keep bailing them out with easier money.

The overarching illusion is that ever-easier monetary policy can return the U.S. economy to a durable expansion and broad-based prosperity. The bill for unbridled government spending stimulus is already coming due. Sooner or later the bill for open-ended monetary stimulus will arrive too.

Rich Dad, Poor Baby

Unless you’ve been hiding under a rock for the past decade, you know there’s a popular financial self-help book series titled Rich Dad, Poor Dad written by Robert Kiyosaki. The basic premise of the numerous books Mr. Kiyosaki has spun out can be stated in a few sentences.

Rich Dad passes on the lessons of financial success, which follow the basic dictum to work, save, borrow to invest, take prudent risks, produce, create value, and sell to accumulate tangible wealth and realize financial freedom. Poor Dad ends his lessons at working hard at a good job in order to retire comfortably and securely after a long and hopefully productive career. Poor Dad tends to borrow to bridge consumptions needs and income, in effect buying cars and homes with credit and debt.

The difference here is that Poor Dad’s wealth-creating productivity is captured by someone else, usually an employer or financier, who is taking the risks that pay his salary. In effect, the Poor Dad has traded financial freedom for security, and perhaps foregone accumulated wealth to pass on to heirs in return for future pension promises that may expire with his final breath. Mr. Kiyosaki’s insight is that too many choose Poor Dad’s strategy because they mistakenly feel they have little choice. (Rich Dad’s strategies to invest and accumulate wealth can take an infinite number of forms, but Mr. Kiyosaki’s main strategy is highly-leveraged investment real estate, a profitable strategy in the past because it’s subsidized by government tax and credit policies. Profitable, at least until everybody else tries to get in on the action and inflates prices into a “bubble.”)

The Rich Dad, Poor Dad financial formula can help illuminate the similar choices we face as a nation. From an economic perspective we see that Rich Dad produces more and consumes less of his income, while Poor Dad consumes a greater share of his income. When Poor Dad’s consumption needs outstrip his savings, he borrows against future income. In our current political vernacular, Rich Dad is the 1%, while Poor Dad is the 99% (the true ratios are probably closer to 20-80). At the level of the national economy, the relationship between these two strategies is symbiotic; in other words, the two need each other to thrive in order to survive. Their relationship is simply stated: Without consumers, producers have no market and without producers, consumers have no goods.

The problem is that as a nation, we’ve adopted Poor Dad’s financial strategy. We’ve taxed work, savings, production, investment and capital accumulation, while subsidizing debt and over-consumption. This is marked by greater dependence on government income security in the form of unfunded entitlements (Social Security, Medicare, Medicaid, Obamacare) and the explosion of debt to manage inadequate present consumption demand by borrowing it from the future. The interest on those trillion dollar deficits and $16+ trillion dollar debt will have to be serviced by future tax dollars that will reduce future consumption demand. In effect, the wannabe Rich Dads (and Moms) of today are pushing the burden of unfunded entitlements and debt off on future generations, or the Poor Babies.

One might be tempted to make partisan political hay out of this shameful fact, but both parties and all voters are complicit in the national scam. One party spouts empty rhetoric about ending the tax and spending regime but does little, while the other party puts the pedal to the metal to gain votes. The big government, pro-entitlement pushers expect that future generations will see the wisdom of paying higher taxes and settling for less in order to pay for cradle-to-grave security, but there’s good reason to question this assumption. It seems to directly contradict the technology trend toward greater autonomy and freedom of choice that younger generations have come to take for granted. One thing is for sure, greater dependency on social entitlements must come at the cost of less personal autonomy and freedom of choice. In other words, less freedom. This was not supposed to be Rich Dad’s legacy.

Plus ça change, plus c’est la même chose…

Good quote from the past…

H.L. Mencken, writing in the 1930s, collected in “A Mencken Chrestomathy”:

Here is the perfect pattern of a professional world-saver. His whole life has been devoted to the art and science of spending other people’s money. He has saved millions of the down-trodden from starvation, pestilence, cannibalism, and worse—always at someone else’s expense, and usually at the taxpayer’s. . . .

Of such sort are the young wizards who now sweat to save the plain people from the degradations of capitalism, which is to say, from the degradations of working hard, saving their money, and paying their way. This is what the New Deal and its Planned Economy come to in practise—a series of furious and irrational raids upon the taxpayer, planned casually by professional do-gooders lolling in smoking cars, and executed by professional politicians bent only upon building up an irresistible machine.