The View From 1776

Las Vegas and the Fed

Prudent investors planning for the long term don’t gamble by putting every penny in the stock market.  Why then are we willing to gamble the nation’s future on speculative monetary policy?

Managed money, artificially controlled by the Federal Reserve, has been around for three generations.  Most people never think about it, or they assume that it has always been so.

The unpleasant fact is that the Federal Reserve cannot be trusted to prevent inflation by guessing correctly, even when it ardently wishes to do so.  Alan Greenspan, while he was Fed chairman, never stated an interest rate goal, but always spoke of finding a balance that could be known only after the fact.

An article in the April 13, 2006, edition of the Wall Street Journal underlines the degree of speculative guessing in Fed manipulation:

“Federal Reserve Governor Donald Kohn said Thursday that he’s unsure how much monetary policy tightening will be needed to keep inflation low, but with resource utilization at levels that in the past generated inflation, he’s staying focused on keeping price pressures well anchored….

“A tendency for inflation to move higher would put economic stability and the long-term performance of the economy at risk,” he said.”

President Roosevelt’s New Deal took our currency out of the free market and placed it in the hands of a collectivist cabal of intellectuals.  Whether intent upon controlling inflation or aiming to inflate the currency to benefit labor unions or farmers, they are in the same position as you are when you try to out-guess the stock market.

In contrast, under the McKinley administration’s 1900 Gold Standard Act there was far less leeway for guessing and manipulation.  If the dollar became inflated by excessive bank credit that falsely stimulated demand for products, foreign exchange dealers and central banks around the world would exchange their dollars for gold from the United States Treasury.  Unlike today’s money manufactured by Fed bookkeeping, only a fixed quantity of gold was available at any given time.  Excessive credit had to be curtailed immediately to stem the gold outflow.

In the 19th century, while the Bank of England drifted from gold standard orthodoxy from time to time, the Pound Sterling was convertible into gold.  Politicians then understood that London’s position as the world’s monetary center depended upon maintenance of a sound currency.  The result was the greatest commercial empire the world has ever seen and a century, without major wars, in which people’s living standards improved more than at any other time in history.

When I was in high school and college in the late 1940s and early 1950s we were told that President Roosevelt had ended the Depression with his brilliant barrage of Federal agencies and welfare-state programs.  And we were taught that the New Deal had solved the problem of managing the economy so that there would never again be a Depression.  It was all so simple: monetary policy would provide adequate credit and keep banks from failing, while fiscal policy would roll out big government construction projects to employ people whenever business activity turned down. 

Unfortunately, none of this was true, either in the 1930s, or subsequently.

As Jim Powell reports in “FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression,” the median annual unemployment rate from 1934 to 1940 was 17.2%, and at no time did it drop below 14%.  (Compare that to today’s 4.7% number, which liberals castigate as the failure of tax cuts to revive the economy.)

Roosevelt in 1933 deliberately instituted a policy of inflating prices, propagandizing it as an effective way to revive business activity and to increase employment, despite the fact that historically such policies always were counterproductive. 

What was propagandized as the brilliant socialistic materialism of the President’s Brain Trusters was no more than old fashioned politics.  FDR wanted votes from farmers and labor unions Since the Populist days of the 1890s, farmers had agitated for cheap money and high farm prices.  Labor unions demanded high wages in the face of depressed production levels.

Cheap money, however, has other consequences.  Banks are loath to lend when they anticipate being repaid in money worth less than what was lent.  Inflation’s short-term stimulation soon becomes an economic drag.  All sorts of dislocations follow.

Businessmen were lambasted in the 1970s and 80s for the failure of S & Ls and for the leveraged-buyout boom.  Neither phenomenon would have occurred absent President Johnson’s Great Society stagflation.

S & Ls lent money with maturities of five to twenty five or thirty years, at fixed interest rates.  Portfolios of loans made at 5% interest rates were worth only 45 cents on the dollar when market interest rates soared to 12% and people took their money out of savings accounts that legally could pay only 4.5%.  S & Ls typically having only about 2% capital and reserves, they were all bankrupt when their assets had to be sold to meet depositor withdrawals.  Crooked businessmen didn’t cause the S & L meltdown; President Johnson’s Great society did.

When inflation prowls the land, investors dump common stocks and put their money into tangible assets ? every thing from gold bullion to jewelry and works of art.  The Dow Jones Index dropped 45% from its high in 1973.  By the late 1970s, the price to buy control of a company via acquiring all of its stock in a leveraged buyout was a fraction of the underlying productive value of its assets.  Leveraged-buyout operators could borrow all of the money need to acquire a company’s stock in a tender offer, sell off some of the company’s assets to repay the acquisition debt, and end up owning the remaining assets with little if any cash invested. 

Unfortunately, employees in dismembered companies often lost their jobs, not because of Hollywood’s “greed is good”, but because of President Johnson’s Great Society inflation.

So long as we permit our money to be managed by politicians via the Federal Reserve, we remain vulnerable to a reprise of those savage times.

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