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Posts Tagged ‘Easy money’

Nothing compares to the depth and substance of Professor George Selgin’s scholarly take-down of the Federal Reserve, but this video by a local libertarian has a very authentic feel.

Julie lists 10 reasons to dislike the Fed.

1.    The Fed has too much power.
2.    The Fed has devalued the currency.
3.    The Fed hurts the poor and middle class.
4.    The Fed is unaccountable.
5.    The Fed destabilizes the economy.
6.    The Fed is too secretive.
7.    The Fed benefits special interests.
8.    The Fed is unconstitutional.
9.    The Fed facilitates bailouts.
10.    The Fed encourages deficit spending.

If I want to nit-pick, I’m not sure that I agree with number 8 since the Constitution gives the federal government the power to coin money. I guess it depends how one interprets that particular power.

Also, I suspect politicians would waste just as much money even if the Fed didn’t exist, so number 10 may be a bit superfluous.

The main argument against the Fed is number 5. Looking at the economic chaos of the 1930s and 1970s, as well as the recent economic crisis, it is no exaggeration to say that the Federal Reserve deserves the lion’s share of the blame.

For those that like monetary policy, here’s my video that looks at the origin of central banking.

And I can’t resist including a link to the famous “Ben Bernank” QE2 video that was a viral smash.

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Europe is in the midst of a fiscal crisis caused by too much government spending, yet many of the continent’s politicians want the European Central Bank to purchase the dodgy debt of reckless welfare states such as Spain, Italy, Greece, and Portugal in order to prop up these big government policies.

So it’s especially noteworthy that economists at the European Central Bank have just produced a study showing that government spending is unambiguously harmful to economic performance. Here is a brief description of the key findings.

…we analyse a wide set of 108 countries composed of both developed and emerging and developing countries, using a long time span running from 1970-2008, and employing different proxies for government size… Our results show a significant negative effect of the size of government on growth. …Interestingly, government consumption is consistently detrimental to output growth irrespective of the country sample considered (OECD, emerging and developing countries).

There are two very interesting takeaways from this new research. First, the evidence shows that the problem is government spending, and that problem exists regardless of whether the budget is financed by taxes or borrowing. Unfortunately, too many supposedly conservative policy makers fail to grasp this key distinction and mistakenly focus on the symptom (deficits) rather than the underlying disease (big government).

The second key takeaway is that Europe’s corrupt political elite is engaging in a classic case of Mitchell’s Law, which is when one bad government policy is used to justify another bad government policy. In this case, they undermined prosperity by recklessly increasing the burden of government spending, and they’re now using the resulting fiscal crisis as an excuse to promote inflationary monetary policy by the European Central Bank.

The ECB study, by contrast, shows that the only good answer is to reduce the burden of the public sector. Moreover, the research also has a discussion of the growth-maximizing size of government.

… economic progress is limited when government is zero percent of the economy (absence of rule of law, property rights, etc.), but also when it is closer to 100 percent (the law of diminishing returns operates in addition to, e.g., increased taxation required to finance the government’s growing burden – which has adverse effects on human economic behaviour, namely on consumption decisions).

This may sound familiar, because it’s a description of the Rahn Curve, which is sort of the spending version of the Laffer Curve. This video explains.

The key lesson in the video is that government is far too big in the United States and other industrialized nations, which is precisely what the scholars found in the European Central Bank study.

Another interesting finding in the study is that the quality and structure of government matters.

Growth in government size has negative effects on economic growth, but the negative effects are three times as great in non-democratic systems as in democratic systems. …the negative effect of government size on GDP per capita is stronger at lower levels of institutional quality, and ii) the positive effect of institutional quality on GDP per capita is stronger at smaller levels of government size.

The simple way of thinking about these results is that government spending doesn’t do as much damage in a nation such as Sweden as it does in a failed state such as Mexico.

Last but not least, the ECB study analyzes various budget process reforms. There’s a bit of jargon in this excerpt, but it basically shows that spending limits (presumably policies similar to Senator Corker’s CAP Act or Congressman Brady’s MAP Act) are far better than balanced budget rules.

…we use three indices constructed by the European Commission (overall rule index, expenditure rule index, and budget balance and debt rule index). …The former incorporates each index individually whereas the latter includes interacted terms between fiscal rules and government size proxies. Particularly under the total government expenditure and government spending specifications…we find statistically significant positive coefficients on the overall rule index and the expenditure rule index, meaning that having these fiscal numerical rules improves GDP growth for these set of EU countries.

This research is important because it shows that rules focusing on deficits and debt (such as requirements to balance the budget) are not as effective because politicians can use them as an excuse to raise taxes.

At the risk of citing myself again, the number one message from this new ECB research is that lawmakers – at the very least – need to follow Mitchell’s Golden Rule and make sure government spending grows slower than the private sector. Fortunately, that can happen, as shown in this video.

But my Golden Rule is just a minimum requirement. If politicians really want to do the right thing, they should copy the Baltic nations and implement genuine spending cuts rather than just reductions in the rate of growth in the burden of government.

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In hopes of stopping investor panic about Europe’s fiscal crisis, the world’s major central banks just announced that they will do whatever is needed to ensure financial markets don’t freeze up.

This could be an appropriate and relatively benign use of the lender-of-last-resort powers, or it could signal another round of reckless easy money and quantitative easing.

I’m skeptical of the Fed and other central banks, but I don’t want to play back-seat driver on monetary policy. Instead, I want to focus on the underlying issue, which is whether there is any alternative to immediate – and real – spending cuts.

Maybe there is some way to muddle through, but I think the answer is no. Easy money from central banks is not a solution. Bailouts from the IMF or some other entity are not the solution.

In this interview with Neil Cavuto, I explain that more bailouts won’t work and that Europe’s welfare states should copy the Baltic nations and shrink the burden of government spending.

One point I made deserves to be emphasized. We wouldn’t be in the current mess if the political elite at the IMF and in Europe and the United States had followed my sage advice and rejected the original bailout for Greece.

The Wall Street Journal agrees. Here’s a passage from today’s editorial page.

Europe’s original sin in this crisis was not letting Greece default, remaining in the euro but shrinking its debt load as it reformed its economy. The example would have sent a useful message of discipline to countries and creditors alike. The fear at the time was that a default would spread the contagion of higher bond rates, but those rates have soared despite the bailouts of Greece and Portugal.

Sadly, I expect more bad policies. Politicians are addicted to big government, so they’ll always take the primrose path of bailouts and easy money as an alternative to fiscal restraint. Especially when the United States is a source of laughably bad advice from the clowns in the Obama Administration.

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Welcome Instapundit readers: If you want a longer-term perspective on the Fed’s misdeeds, this George Selgin analysis is highly recommended.

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In a move that some are calling QE3, the Federal Reserve announced yesterday that it will engage in a policy called “the twist” – selling short-term bonds and buying long-term bonds in hopes of artificially reducing long-term interest rates. If successful, this policy (we are told) will incentivize more borrowing and stimulate growth.

I’ve freely admitted before that it is difficult to identify the right monetary policy, but it certainly seems like this policy is – at best – an ineffective gesture. This is why the Fed’s various efforts to goose the economy with easy money have been described as “pushing on a string.”

Here are two related questions that need to be answered.

1. Is the economy’s performance being undermined by high long-term rates?

Considering that interest rates are at very low levels already, it seems rather odd to claim that the economy will suddenly rebound if they get pushed down a bit further. Japan has had very low interest rates (both short-run and long-run) for a couple of decades, yet the economy has remained stagnant.

Perhaps the problem is bad policy in other areas. After all, who wants to borrow money, expand business, create jobs, and boost output if Washington is pursuing a toxic combination of excessive spending and regulation, augmented by the threat of higher taxes.

2. Is the economy hampered by lack of credit?

Low interest rates, some argue, may not help the economy if banks don’t have any money to lend. Yet I’ve already pointed out that banks have more than $1 trillion of excess reserves deposited at the Fed.

Perhaps the problem is that banks don’t want to lend money because they don’t see profitable opportunities. After all, it’s better to sit on money than to lend it to people who won’t pay it back because of an economy weakened by too much government.

The Wall Street Journal makes all the relevant points in its editorial.

The Fed announced that through June 2012 it will buy $400 billion in Treasury bonds at the long end of the market—with six- to 30-year maturities—and sell an equal amount of securities of three years’ duration or less. The point, said the FOMC statement, is to put further “downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.” It’s hard to see how this will make much difference to economic growth. Long rates are already at historic lows, and even a move of 10 or 20 basis points isn’t likely to affect many investment decisions at the margin. The Fed isn’t acting in a vacuum, and any move in bond prices could well be swamped by other economic news. Europe’s woes are accelerating, and every CEO in America these days is worried more about what the National Labor Relations Board is doing to Boeing than he is about the 30-year bond rate. The Fed will also reinvest the principal payments it receives on its asset holdings into mortgage-backed securities, rather than in U.S. Treasurys. The goal here is to further reduce mortgage costs and thus help the housing market. But home borrowing costs are also at historic lows, and the housing market suffers far more from the foreclosure overhang and uncertainty encouraged by government policy than it does from the price of money. The Fed’s announcement thus had the feel of an attempt to show it is doing something to help the economy, even if it can’t do much. …the economy’s problems aren’t rooted in the supply and price of money. They result from the damage done to business confidence and investment by fiscal and regulatory policy, and that’s where the solutions must come. Investors on Wall Street and politicians in Washington want to believe that the Fed can make up for years of policy mistakes. The sooner they realize it can’t, the sooner they’ll have no choice but to correct the mistakes.

Let’s also take this issue to the next level. Some people are explicitly arguing in favor of more “quantitative easing” because they want some inflation. They argue that “moderate” inflation will help the economy by indirectly wiping out some existing debt.

This is a very dangerous gambit. Letting the inflation genie out of the bottle could trigger 1970s-style stagflation. Paul Volcker fires a warning shot against this risky approach in a New York Times column. Here are the key passages.

…we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes. The siren song is both alluring and predictable. …After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? …all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth. …What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate. …At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.

Last but not least, here is my video on the origin of central banking, which starts with an explanation of how currency evolved in the private sector, then describes how governments then seized that role by creating monopoly central banks, and closes with a list of options to promote good monetary policy.

And I can’t resist including a link to the famous “Ben Bernank” QE2 video that was a viral smash.

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I generally try to avoid commenting on monetary policy. Not because I don’t have opinions, but for the simple reason that I don’t follow the issue closely enough to feel fully confident about what I say.

This doesn’t mean I’m happy with Fed Chairman Bernanke. But I’m most likely to be upset that he is making misguided statements about fiscal policy (endorsing the faux stimulus, endorsing bailouts, endorsing tax increases, and siding with Obama on the debt-limit fight).

On monetary policy, as I’ve previously explained, it’s possible that “easy money” is the right approach. I’m skeptical, but I admitted on CNBC that the TIPS data does suggest that future inflation is not a problem.

So with all these caveats out of the way, I don’t embrace everything in this video, which is very critical of the Fed, but it’s amusing and worth sharing.

If you find it even remotely interesting and/or amusing, then you definitely should watch the famous Ben-Bernank-quantitative-easing video.

And if you want to actually understand more about the Federal Reserve and monetary policy, then you should watch this video on the history of the Fed featuring Professor George Selgin.

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To put it mildly, the Federal Reserve has a dismal track record. It bears significant responsibility for almost every major economic upheaval of the past 100 years, including the Great Depression, the 1970s stagflation, and the recent financial crisis. Perhaps the most damning statistic is that the dollar has lost 95 percent of its value since the central bank was created.

Notwithstanding its poor performance, the Federal Reserve seems to get more power over time. But rather than rewarding the central bank for debasing the currency and causing instability, perhaps it’s time to contemplate alternatives. This new video from the Center for Freedom and Prosperity dives into that issue, exposing the Fed’s poor track record, explaining how central banking evolved, and mentioning possible alternatives.

This video is the first installment of a multi-part series on monetary policy. Subsequent videos will examine possible alternatives to monopoly central banks, including a gold standard, free banking, and monetary rules to limit the Fed’s discretion.

One of the challenges in this field is that opponents of the Fed often are portrayed as cranks. Defenders of the status quo may not have a good defense of the Fed, but they are rather effect in marginalizing critics. Congressman Ron Paul and others are either summarily dismissed or completely ignored.

The implicit assumption in monetary circles is that there is no alternative to central banking and fiat money. Anybody who criticizes the current system therefore is a know-nothing who wants to create some sort of libertarian dystopia featuring banking panics and economic chaos.

To be fair, it certainly might be possible to create a monetary regime that is worse than the Fed. That is why the next videos in this series will offer a careful look at the costs and benefits of possible alternatives.

As they say, stay tuned.

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A lot of guests for this appearance, but I think I got a fair share of airtime. More important, I explained why it is not a good thing for Ben Bernanke and the Federal Reserve to let the inflation genie out of the bottle.

Monetary policy is one area where I always try to display some humility. While I know the right goal is zero inflation, I realize that achieving that goal requires central bankers to know both the supply of money (not as easy as it used to be) and the demand for money (always a challenge).

This is why I’m skeptical of QE2, but also willing to admit that it might be the right approach (though it grates on me that it is often portrayed as a form of stimulus, which definitely is wrong).

I’ll soon release a video that begins to tackle monetary policy. I don’t want to give away too much right now, but suffice to say that a monopoly central bank run by government is a recipe for mischief.

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The news is going from bad to worse for Ireland. The Irish Independent is reporting that the Swiss Central Bank no longer will accept Irish government bonds as collateral. The story also notes that one of the world’s largest bond firms, PIMCO, is no longer purchasing debt issued by the Irish government.

And this is happening even though (or perhaps because?) Ireland received a big bailout from the European Union and the International Monetary Fund (and the IMF’s involvement means American taxpayers are picking up part of the tab).

I’ve already commented on Ireland’s woes, and opined about similar problems afflicting the rest of Europe, but the continuing deterioration of the Emerald Isle deserves further analysis so that American policy makers hopefully grasp the right lessons. Here are five things we should learn from the mess in Ireland.

1. Bailouts Don’t Work – When Ireland’s government rescued depositors by bailing out the nation’s three big banks, they made a big mistake by also bailing out creditors such as bondholders. This dramatically increased the cost of the bank bailout and exacerbated moral hazard since investors are more willing to make inefficient and risky choices if they think governments will cover their losses. And because it required the government to incur a lot of additional debt, it also had the effect of destabilizing the nation’s finances, which then resulted in a second mistake – the bailout of Ireland by the European Union and IMF (a classic case of Mitchell’s Law, which occurs when one bad government policy leads to another bad government policy).

American policy makers already have implemented one of the two mistakes mentioned above. The TARP bailout went way beyond protecting depositors and instead gave unnecessary handouts to wealthy and sophisticated companies, executives, and investors. But something good may happen if we learn from the second mistake. Greedy politicians from states such as California and Illinois would welcome a bailout from Uncle Sam, but this would be just as misguided as the EU/IMF bailout of Ireland. The Obama Administration already provided an indirect short-run bailout as part of the so-called stimulus legislation, and this encouraged states to dig themselves deeper in a fiscal hole. Uncle Sam shouldn’t be subsidizing bad policy at the state level, and the mess in Europe is a powerful argument that this counterproductive approach should be stopped as soon as possible.

By the way, it’s worth noting that politicians and international bureaucracies behave as if government defaults would have catastrophic consequences, but Kevin Hassett of the American Enterprise Institute explains that there have been more than 200 sovereign defaults in the past 200 years and we somehow avoided Armageddon.

2. Excessive Government Spending Is a Path to Fiscal Ruin – The bailout of the banks obviously played a big role in causing Ireland’s fiscal collapse, but the government probably could have weathered that storm if politicians in Dublin hadn’t engaged in a 20-year spending spree.

The red line in the chart shows the explosive growth of government spending. Irish politicians got away with this behavior for a long time. Indeed, government spending as a share of GDP (the blue line) actually fell during the 1990s because the private sector was growing even faster than the public sector. This bit of good news (at least relatively speaking) stopped about 10 years ago. Politicians began to increase government spending at roughly the same rate as the private sector was expanding. While this was misguided, tax revenues were booming (in part because of genuine growth and in part because of the bubble) and it seemed like bigger government was a free lunch.

Eventually, however, the house of cards collapsed. Revenues dried up and the banks failed, but because the politicians had spent so much during the good times, there was no reserve during the bad times.

American politicians are repeating these mistakes. Spending has skyrocketed during the Bush-Obama year. We also had our version of a financial system bailout, though fortunately not as large as Ireland’s when measured as a share of economic output, so our crisis is likely to occur when the baby boom generation has retired and the time comes to make good on the empty promises to fund Social Security, Medicare, and Medicaid.

3. Low Corporate Tax Rates Are Good, but They Don’t Guarantee Economic Success if other Policies Are Bad – Ireland used to be a success story. They went from being the “Sick Man of Europe” in the early 1980s to being the “Celtic Tiger” earlier this century in large part because policy makers dramatically reformed fiscal policy. Government spending was capped in the late 1980 and tax rates were reduced during the 1990s. The reform of the corporate income tax was especially dramatic. Irish lawmakers reduced the tax rate from 50 percent all the way down to 12.5 percent.

This policy was enormously successful in attracting new investment, and Ireland’s government actually wound up collecting more corporate tax revenue at the lower rate. This was remarkable since it is only in very rare cases that the Laffer Curve means a tax cut generates more revenue for government (in the vast majority of cases, the Laffer Curve simply means that changes in taxable income will have revenue effects that offset only a portion of the revenue effects caused by the change in tax rates).

Unfortunately, good corporate tax policy does not guarantee good economic performance if the government is making a lot of mistakes in other areas. This is an apt description of what happened to Ireland. The silver lining to this sad story is that Irish politicians have resisted pressure from France and Germany and are keeping the corporate tax rate at 12.5 percent. The lesson for American policy makers, of course, is that low corporate tax rates are a very good idea, but don’t assume they protect the economy from other policy mistakes.

4. Artificially Low Interest Rates Encourage Bubbles – No discussion of Ireland’s economic problems would be complete without looking at the decision to join the common European currency. Adopting the euro had some advantages, such as not having to worry about changing money when traveling to many other European nations. But being part of Europe’s monetary union also meant that Ireland did not have flexible interest rates.

Normally, an economic boom drives up interest rates because the plethora of profitable opportunities leads investors demand more credit. But Ireland’s interest rates, for all intents and purposes, were governed by what was happening elsewhere in Europe, where growth was generally anemic. The resulting artificially low interest rates in Ireland helped cause a bubble, much as artificially low interest rates in America last decade led to a bubble.

But if America already had a bubble, what lesson can we learn from Ireland? The simple answer is that we should learn to avoid making the same mistake over and over again. Easy money is a recipe for inflation and/or bubbles. Simply stated, excess money has to go someplace and the long-run results are never pleasant. Yet Ben Bernanke and the Federal Reserve have launched QE2, a policy explicitly designed to lower interest rates in hopes of artificially juicing the economy.

5. Housing Subsidies Reduce Prosperity – Last but not least, Ireland’s bubble was worsened in part because politicians created an extensive system of preferences that tilted the playing field in the direction of real estate. The combination of these subsidies and the artificially low interest rates caused widespread malinvestment and Ireland is paying the price today.

Since we just endured a financial crisis caused in large part by a corrupt system of housing subsidies for Fannie Mae and Freddie Mac, American policy makers should have learned this lesson already. But as Thomas Sowell sagely observes, politicians are still fixated on somehow re-inflating the housing bubble. The lesson they should have learned is that markets should determine value, not politics.

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The Chairman of the Federal Reserve is such a swell guy, but you already would know that if you saw his Facebook page. Well, thanks to his “QE2 plan,” he’s giving the rest of us a very thoughtful Christmas present.

To be fair, I suppose it should be noted that Bernanke’s policy isn’t necessarily a bad idea – but only if you think that there will be future deflation and “quantitative easing” is the way of preventing that from happening. I’m quite skeptical, as explained here, but freely admit that I’m not a monetary policy expert (thanks for catching my mistake, Charlie). But Christmas isn’t the right time for serious discussion, so let’s just enjoy a laugh and keep our fingers crossed that we’re not heading into Jimmy Carter Inflation-land.

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Fed Chairman Ben Bernanke is at it again, giving an interview that combines all of the worst features of Keynesian economics. I have an excerpt below from a New York Times report, which features an amazing amount of mistakes in a very short amount of space. Here are three that demand correction.

1. The economy needs less government intervention, not more “government help.” Bernanke doesn’t understand that job creation and entrepreneurship are hurting because politicians are doing too much, yet he wants more interference from Washington.

2. The economy needs less government spending, not Keynesian nonsense about big deficits to boost consumer spending. Bernanke seems to think so-called stimulus schemes for more wasteful spending help the economy, even though those policies failed for Hoover, Roosevelt, Bush, and Obama.

3. The economy needs a strong and stable dollar, not inflationary quantitative easing. Bernanke wants us to believe that low interest rates are the key to growth, but apparently oblivious to the fact that interest rates are very low now (and have been very low in Japan during that country’s 20-year stagnation. Memo to Ben: People don’t invest when they expect to lose money, regardless of interest rates.

Here’s the excerpt about Helicopter Ben’s thinking:

Federal Reserve Chairman Ben Bernanke is stepping up his defense of the Fed’s $600 billion Treasury bond-purchase plan, saying the economy is still struggling to become “self-sustaining” without government help. In a taped interview with CBS’ “60 Minutes” that aired Sunday night, Bernanke also argued that Congress shouldn’t cut spending or boost taxes given how fragile the economy remains. The Fed chairman said he thinks another recession is unlikely. But he warned that the economy could suffer a slowdown if persistently high unemployment dampens consumer spending. The interview is part of a broad counteroffensive Bernanke has been waging against critics of the bond purchase plan the Fed announced Nov. 3. The purchases are intended to lower long-term interest rates, lift stock prices and encourage more spending to boost the economy.

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Thanks to the folks at the Mises Institute, Professor George Selgin of the University of Georgia (!) has a superb presentation on the failings of the Federal Reserve. George was one of my professors at George Mason University back in the 1980s and is one of the world’s experts on competing currencies. This video is 1,000-times more substantive than the famous “QE2” video I posted last month. Fed bashing is fun, but watch this if you want to understand economics and history.

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Maybe I’m crazy, or maybe I’m just getting into the Christmas spirit, but I saw this photo of Fed Chairman Ben Bernanke on the Drudge Report and my mind instantly connected his image with this character from “The Grinch Who Stole Christmas.”

This might explain Bernanke’s QE2 policy. I can see a film being released in time for next year’s holiday season: “The Grinch Who Debased the Dollar.”

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I’m utterly envious at how this video has gone viral, but I have to admit that it is quite clever. I don’t think my flat tax videos, for instance, have quite the same flair. In any event, one imagines “the Ben Bernank” is probably not happy about  this production.

If you really want to understand the Federal Reserve’s shortcomings, however, you should read this new Cato Institute working paper. Here’s the abstract.

As the one-hundredth anniversary of the 1913 Federal Reserve Act approaches, we assess whether the nation‘s experiment with the Federal Reserve has been a success or a failure. Drawing on a wide range of recent empirical research, we find the following: (1) The Fed‘s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed‘s establishment. (2) While the Fed‘s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I. (3) Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.

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I have a column in today’s New York Post, where I pull no punches as I comment on how the rest of the world is increasingly worried about Obama’s policies of easy money and deficit spending. I note that other nations often are guilty of the same mistakes, but that’s no excuse for America sinking to that level.

Along with countries such as Germany, Brazil and South Africa, China’s worried that President Obama and Bernanke will destabilize the global economy by dumping too much money into the system. This distorts trade, creates bubbles and may prompt other nations to engage in similar devaluations. The fact that China is probably guilty of the same thing doesn’t change the fact that America is on the wrong path. …The monetary move is isn’t the only Obama policy causing unease around the globe. Having seen the destructive impact of too much deficit spending in nations such as Greece, Ireland and Spain, policymakers worldwide increasingly recognize that countries need to reduce the burden of government spending to prevent a spread of sovereign-debt crises. Nations such as Germany and the United Kingdom haven’t approached this issue in the best way. Too often, they’re using the fiscal crisis as an excuse to raise taxes rather than make long-overdue reductions in bloated budgets. But at least they recognize that the time has come to back away from the abyss of too much red ink. The United States, by contrast, is on a spending binge of historic proportions. …Some of these fears are overblown. Yes, the Bush-Obama years have dramatically boosted the burden of government, and one obvious symptom of this fiscal excess is a much bigger national debt. But America’s red ink, as a share of GDP, is lower than the comparable levels in many European nations, as well as Japan. But that’s hardly an excuse. We all tell our kids that their friends’ misbehavior is no excuse for them to the wrong thing as well. This is a good rule for the global economy. If China is keeping its currency artificially weak, that doesn’t mean we should do the same thing. If European nations have bigger governments and more debt, that doesn’t mean we should copy their mistakes.

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One of my first blog posts (and the first one to get any attention) highlighted the amusing/embarrassing irony of having Chinese students laugh at Treasury Secretary Geithner when he claimed the United States had a strong-dollar policy.

I suspect that even Tim “Turbotax” Geithner would be smart enough to avoid such a claim today, not after the Fed’s announcement (with the full support of the White House and Treasury) that it would flood the economy with $600 billion of hot money.

As I noted in an earlier post, monetary policy is not nearly as cut and dried as other issues, so I’m reluctant to make sweeping and definitive statements. That being said, I’m fairly sure that the Fed is on the wrong path. Here’s what my colleague Alan Reynolds wrote in the Wall Street Journal about Bernanke’s policy.

Mr. Bernanke…believes (contrary to our past experience with stagflation) that inflation is no danger thanks to economic slack (high unemployment). He reasons that if people can nonetheless be persuaded to expect higher inflation, regardless of the slack, that means interest rates will appear even lower in real terms. If that worked as planned, lower real interest rates would supposedly fix our hangover from the last Fed-financed borrowing binge by encouraging more borrowing. This whole scheme raises nagging questions. Why would domestic investors accept a lower yield on bonds if they expect higher inflation? And why would foreign investors accept a lower yield on U.S. bonds if they expect exchange rate losses on dollar-denominated securities? Why wouldn’t intelligent people shift their investments toward commodities or related stocks (such as mining and related machinery) and either shun, or sell short, long-term Treasurys? And if they did that, how could it possibly help the economy?

The rest of the world seems to share these concerns. The Germans are not big fans of America’s binge of borrowing and easy money. Here’s what Finance Minister Wolfgang Schäuble had to say in a recent interview.

The American growth model, on the other hand, is in a deep crisis. The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies. …I seriously doubt that it makes sense to pump unlimited amounts of money into the markets. There is no lack of liquidity in the US economy, which is why I don’t recognize the economic argument behind this measure. …The Fed’s decisions bring more uncertainty to the global economy. …It’s inconsistent for the Americans to accuse the Chinese of manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money.

The comment about borrowed money has a bit of hypocrisy since German government debt is not much lower than it is in the United States, but the Finance Minister surely is correct about monetary policy. And speaking of China, we now have the odd situation of a Chinese rating agency downgrading U.S. government debt.

The United States has lost its double-A credit rating with Dagong Global Credit Rating Co., Ltd., the first domestic rating agency in China, due to its new round of quantitative easing policy. Dagong Global on Tuesday downgraded the local and foreign currency long-term sovereign credit rating of the US by one level to A+ from previous AA with “negative” outlook.

This development shold be taken with a giant grain of salt, as explained by a Wall Street Journal blogger. Nonetheless, the fact that the China-based agency thought this was a smart tactic must say something about how the rest of the world is beginning to perceive America.

Simply stated, Obama is following Jimmy Carter-style economic policy, so nobody shoud be surprised if the result is 1970s-style stagflation.

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Chairman Ben Bernanke has announced that the Federal Reserve will buy about $600 billion of government bonds as part of what is being called QE2 (because this is the second big stage of “quantitative easing”).

This actually isn’t printing money, but it has the same effect in that it creates more liquidity by putting more money into the financial system. The theory is that all this extra money will drive down interest rates, and that lower interest rates will encourage people to take on more debt to finance additional spending.

There are several reasons why this is a bad idea and one potential argument why it is a good idea.

* It is a bad idea because rising prices are the inevitable result when there is more money chasing the same amount of goods.

* It is a bad idea because it assumes that the economy is weak because of high low interest rates. That is nonsense. Interest rates already are very low. Trying to drive them lower in hopes of stimulating borrowing is like pushing on a string.

* It is a bad idea because you don’t solve bad fiscal and regulatory policy with bad monetary policy. The economy is weak in considerable part because of too much spending, new health care interventions, and the threat of higher taxes. You don’t solve those problems by printing money, just like you don’t make rotting fish taste good with ketchup.

* It is a bad idea because the easy-money policy of artificially low interest rates helped create the housing bubble and financial crisis, and “hair of the dog” is not the right approach.

* It is a bad idea because no nation becomes economically strong with a weak currency.

* It is a bad idea because it may lead to “competitive devaluation,” as other nations copy the Fed’s misguided policy in hopes of keeping their exports affordable.

So what about arguments in favor of the Fed’s policy? There’s only one possible reason to support Bernanke’s policy, and at least one monetarist friend has offered this as justification for what is happening. I hope he’s right.

* The only legitimate argument for quantitative easing is if more money needs to be put in the system to counteract deflation. In other words, if the Fed focuses on its one appropriate responsibility – price stability, and if there is a legitimate concern of falling prices in the future, then an “easy-money” policy today could offset that future deflation.

By the way, some people say that the stock market’s recent performance is a sign that Bernanke’s policy is good for the economy. This is wrong because it confuses portfolio shifting with long-term economic performance. When the Fed creates liquidity, that drives down interest rates. What does that mean for investors? Well, it means that putting money into bonds will yield a lower return, so the only other major option is stocks. That is why Fed policy often leads (seemingly inexplicably) to short-term results that are at odds with the long-term consequences.

Here are some excerpts from a Bloomberg report.

Federal Reserve Chairman Ben S. Bernanke said the central bank must focus on the U.S. rather than overseas economies when trying to spur the recovery by purchasing an additional $600 billion in Treasuries. …Bernanke came under fire yesterday from officials in Germany, China, and Brazil, who said his plan to pump cash into the banking system may jar other economies and fail to fuel U.S. growth. Critics including Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, have said Fed policy is encouraging investors to take on too much risk and threatens to undermine the dollar. …“We are showing insufficient stimulus,” Bernanke said yesterday in his remarks, mostly in response to questions. Asset purchases have “the goal of reducing interest rates, providing more stimulus to the economy and, we hope, creating a faster recovery and an inflation rate consistent with long-run stability,” Bernanke said to students.

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George Melloan’s column in the Wall Street Journal discusses the new Basel capital standards and correctly observes that 22 years of global banking regulations have not generated good results. This is not because requiring reserves is a bad thing, but rather because such policies do nothing to fix the real problem. In the case of the United States, easy money policy by the Fed and a corrupt system of Fannie Mae/Freddie Mac subsidies caused the housing bubble and resulting financial crisis. Yet these problems have not been addressed, either in the Dodd-Frank bailout bill or the new Basel rules. Indeed, Melloan points out that Fannie and Freddie were exempted from the Dood-Frank legislation.

There’s something to be said for holding banks to higher capital standards, even at the cost of more constrained lending and slower economic growth. But the much-bruited idea that Basel rules will make the world freer of financial crises is highly doubtful, given current political circumstances. The 2008 financial meltdown was not primarily the result of lax regulation but of co-option and abuse of the U.S. financial system by the political class in Washington. The federal government’s “affordable housing” endeavors, beginning in the 1990s, allowed and even forced banks to make highly risky mortgage loans. Those loans were folded into mortgage-backed securities (MBS) sold in vast numbers throughout the world, most promiscuously by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The Federal Reserve contributed a credit bubble that caused house prices to soar, a classic asset inflation. When the bubble began to deflate in 2007, the bad loans in mortgage securities became poisonous. The MBS market seized up, and financial institutions holding them became illiquid and began to crash. The Lehman Brothers collapse was the biggest shock. The only way Basel standards might have helped prevent this would have been if they had been applied to Fannie and Freddie as well as to banks. They weren’t. President Bill Clinton exempted the two giants from Basel capitalization rules because they were the primary instruments of a federal policy aimed at helping more lower-income people become homeowners. This was a laudable goal that ultimately wrecked the housing and banking industries. Washington has learned nothing from this debacle, which is why the next financial crisis is likely to have federal policy origins and may come sooner than we think. Fannie and Freddie—now fully controlled by Uncle Sam and exempt from the Dodd-Frank financial “reform” legislation—are still going strong, guaranteeing and restructuring loans while they continue to rack up huge losses for taxpayers. …The record since the Basel process began 22 years ago doesn’t generate faith in banking regulation either. Basel rules didn’t prevent the collapse of Japanese banking in 1990, they didn’t prevent the 2008 meltdown, and they are not preventing the banking failures that plague the financial system even today.

P.S. The bureaucrats and regulators who put together the Basel capital standards were the ones who decided that mortgage-backed securities were very safe assets and required less capital. That was a common assumption at the time, so the point is not that the Basel folks are particularly incompetent, but rather that regulation is a very poor substitute for market discipline. Letting financial firms go bankrupt instead of bailing them out would be a far better way of encouraging prudence.

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Appearing on Fox Business News, I summarize the many reasons why the Bush-Paulson-Obama-Geithner TARP bailout was – and still is – bad policy.

I’m sure I have plenty of flaws, but at least I am philosophically consistent. Here’s what I said about the issue more than 18 months ago. The core message is the same (though I also notice I have a bad habit of starting too many sentences with “well”).

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A number of economists have been warning about the Federal Reserve’s easy-money policy, but defenders of the central bank often ask, “if there’s an easy money policy, why isn’t that showing up in the form of higher prices?” Thomas Sowell has an answer to this question, explaining that people and businesses are sitting on cash because anti-business policies have dampened economic activity.

Not only has all the runaway spending and rapid escalation of the deficit to record levels failed to make any real headway in reducing unemployment, all this money pumped into the economy has also failed to produce inflation. The latter is a good thing in itself but its implications are sobering. How can you pour trillions of dollars into the economy and not even see the price level go up significantly? Economists have long known that it is not just the amount of money, but also the speed with which it circulates, that affects the price level. Last year the Wall Street Journal reported that the velocity of circulation of money in the American economy has plummeted to its lowest level in half a century. Money that people don’t spend does not cause inflation. It also does not stimulate the economy. The current issue of Bloomberg Businessweek has a feature article about businesses that are just holding on to huge sums of money. They say, for example, that the pharmaceutical company Pfizer is holding on to $26 billion. If so, there should not be any great mystery as to why they don’t invest it. With the Obama administration being on an anti-business kick, boasting of putting their foot on some business’ neck, and the president talking about putting his foot on another part of the anatomy, with Congress coming up with more and more red tape, more mandates and more heavy-handed interventions in businesses, would you risk $26 billion that you might not even be able to get back, much less make any money on the deal? Pfizer is not unique. Banks have cut back on lending, despite all the billions of dollars that were dumped into them in the name of “stimulus.” Consumers have also cut back on spending. For the first time, more gold is being bought as an investment to be held as a hedge against a currently non-existent inflation than is being bought by the makers of jewelry. There may not be any inflation now, but eventually that money is going to start moving, and so will the price level.

I do my best to avoid monetary policy issues and certainly am not an expert on the subject, so I asked a few people for their thoughts and was told that perhaps the strongest evidence for Sowell’s hypothesis comes from the Federal Reserve’s data on “Aggregate Reserves of Depository Institutions” – specifically the figures on excess reserves. This is the money that banks keep at the Federal Reserve voluntarily because they don’t have any better options. As you can see from the chart, excess reserves shot up during the financial crisis. But what’s important is that they did not come back down afterwards. Some people refer to this as “money on the sidelines” and Sowell clearly is worried that it will have an impact on the price level if banks start circulating it. That doesn’t sound like good news. On the other hand, it’s not exactly good news that banks are holding money at the Fed because there are not enough profitable opportunities.

What this really tells us is that the combination of easy money and big government isn’t working any better today than it did in the 1970s.

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Kudos to the federal appeals court that just ruled that the Federal Reserve has no right to hide the sordid special handouts it provided to well-connected financial firms. Here’s an excerpt from a report about the decision:

The Federal Reserve must reveal documents identifying financial companies that received Fed loans to survive the financial crisis, a federal appeals court ruled Friday. A panel of the 2nd U.S. Circuit Court of Appeals in Manhattan said in two separate opinions that such information isn’t automatically exempt from requests under the Freedom of Information Act. News Corp.’s Fox News Network LLC and Bloomberg L.P. sued separately for details about loans that commercial banks and Wall Street firms received and the collateral they put up. Other news agencies, including The Associated Press, filed briefs with the appellate court in their support. The Fed argued that if it identified banks that drew emergency loans, it could cause a run on those institutions, undermine the loan programs and potentially hurt the economy, and lower-court judges were split on the issue. The Federal Reserve said it’s studying Friday’s ruling.

On a broader note, I’m periodically asked about monetary policy, the Fed, and the financial crisis. I do my best to stay away from the first two topics, largely because my interests are elsewhere (though I did handle the Federal Reserve for the Bush/Quayle transition team, many years in the past). But that does not mean the issues are unimportant. For those that are interested, I recommend two articles, one by George Selgin and the other by Gerald O’Driscoll.

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Steve Pearlstein of the Washington Post has a common-sense column warning about the dangers of the Fed’s easy-money policy. It is possible, to be sure, that the Fed will withdraw (or “soak up”) all this liquidity as the economy recovers, but all the signs suggest that the central bank is kowtowing to the politicians and debasing the currency in order to help politicians create illusory growth. This is a recipe for a return to the 1970s. The bad policy started under Bush (and Greenspan) and is continuing under Obama (and Bernanke):

The Federal Reserve is still going through its “lessons-learned” exercise from the recent financial crisis, but there’s one lesson it clearly has not yet absorbed — the one about ignoring and enabling credit bubbles. That’s the only conclusion that can be drawn from the Fed’s decision last week to not only keep its benchmark interest rates at zero but also let everyone know that it intends to leave them there for a good long time. …Not surprisingly, all of this sparked a week-long party in financial markets that had already experienced powerful rallies over the past six months. Even with Thursday’s modest pullback on Wall Street, U.S. stocks are up 60 percent since March, and share prices in emerging markets have nearly doubled. Commodity prices are soaring once again, led by gold, which is now selling for more than $1,100 an ounce, and crude oil, which is up a whopping 126 percent since February. A rally in the junk-bond and third-world debt markets has driven interest rates back to where they were before the crisis. In urban China, India and Brazil, property prices have doubled in the past year. “The markets are on a sugar high,” Mohamed El-Erian, chief executive of Pimco, the giant money manager, told Newsweek’s Rana Foroohar last week. Judging from how sharply and quickly these prices have risen, it’s a pretty good guess that most of the buying has not been done by long-term investors who are suddenly upbeat about the prospects of global economic growth. The better bet is all this is the handiwork of short-term speculation by banks, hedge funds, private-equity funds and other financial center wise-guys moving as a herd, financing their purchases directly or indirectly with some of that yummy zero-percent money provided courtesy of the Fed. …There’s no way to know how long all this can continue before one of these bubbles finally bursts, the dollar spikes upward and investors all rush to unwind their trades at the same time. But it is a good guess that it will last as long as the Fed and other central banks indicate there is no end in sight for the current cheap-money regime. The longer they wait, the bigger the bubbles, and the bigger the mess to clean up. All of which is why the recent statements by policymakers were so disappointing — and so dangerous.

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Appearing on MSNBC, I engage in some wholesome Fed-bashing.

In my research before appearing on the program, the most shocking factoid I discovered is that the dollar has lost 95 percent of its value since the Fed was created in 1913.

But let’s not forget that the Fed’s accelerate-too-fast/brake-too-hard approach to monetary policy (with the first part generally being the result of trying to artificially goose the economy to help politicians get reelected) is largely responsible for disasters ranging from the Great Depression to the current financial crisis.

And now the Fed is turning the dollar into the Argentine peso by running the printing presses 24/7. What’s not to love?

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Writing in the Wall Street Journal, David Malpass explains why the Fed’s weak-dollar policy (supported by both Bush and Obama) is a recipe for economic decline:

Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin’s Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs. …If stocks double but the dollar loses half its value, who beyond Wall Street are the winners and losers? There’s been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. Rich people got richer, seeing their equity bottom line double. At the same time, the dollar’s value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages. …The solution is a strong U.S. jobs and wealth program. It has to include stable money, a flatter, more competitive tax structure, spending restraint, and common-sense bank regulation so small business lending can restart. …Instead, Washington’s current economic program pushes capital away by weakening the dollar, threatening higher tax rates, borrowing short (the Fed’s near trillion-dollar overnight debt, Treasury’s mounds of bill and note issuance) to lend long (mortgages, student loans, entitlements), doubling down on government subsidies, and rechanneling bank loans to governments and big businesses instead of the small business job-growth engine.

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