Uneasy Money

After the FOMC issued its statement yesterday, the S&P which had been down almost 2 percent rose about 6 percent to close up for the day by about 4 percent.  Presumably, this allayed fears that the Fed would passively allow inflation and NGDP to keep falling.  For the day, the TIPS spread depending on which measure you look at was constant or rose slightly.  However, the yield on Treasuries dropped by 20 basis points on both the 5- and 10-year bonds.  So the real yield dropped by 20 basis points or so, which says that profit expectations are falling or perceived uncertainty is rising.  Nevertheless, the mild and not very helpful statement was at least able to stop the bleeding.  NPR says that Dow futures are down 1 percent before the market opens in a half an hour.  I am not at all sure that the FOMC statement will be enough to turn the tide.  But I also thought that Bernanke’s Jackson Hole speech last August would not do the trick, and it in fact did succeed in turning things around (for a while).  Hold on to your hats.

PS  Does anyone know by how much the yields on the 5- and 10-year Treasuries and TIPS changed after the FOMC press release?

Just to follow up my earlier post about the difference between central banking  and central planning, I would just like to post the following quotation from Hayek’s The Road to Serfdom pp.121-22.

There is, finally, the supremely important problem of combating general fluctuations of economic activity and the recurrent waves of large-scale unemployment which accompany them.  This is, of course, one of the gravest and most pressing problems of our time.  But, though its solution will require much planning (my emphasis) in the good sense, it does not — or at least need not — require that special kind of planning which according to its advocates is to replace the market (my emphasis).  Many economists hope, indeed, that the ultimate remedy may be found in the field of monetary policy, which would involve nothing incompatible even with nineteenth-century liberalism (my emphasis).  Others, it is true, believe that real success can be expected only from the skillful timing of public works undertaken on a very large scale.  This might (my emphasis) lead to much more serious restrictions of the competitive sphere, and, in experimenting in this direction, we shall have to carefully watch our step if we are to avoid making all economic activity progressively more dependent on the direction and volume of government expenditure.  But his is neither the only nor, in my opinion, the most promising way of meeting the gravest threat to economic security.  In any case, the very necessary effort to secure protection against these fluctuations do not lead to the kind of planning which constitutes such a threat to our freedom (my emphasis).

For good measure, here is Hayek in The Constitution of Liberty (pp. 324-25)

The experience of the last fifty years has taught most people the importance of a stable monetary system.  Compared with the preceding century, this period has been one of great monetary disturbances.  Governments have assumed a much more active part in controlling money, and this has been as much a cause as a consequence of instability.  It is only natural, therefore, that some people should feel it would be better if governments were deprived of their control over monetary policy.  Why, it is sometimes asked, should we not rely on the spontaneous forces of the market to supply whatever is needed for a satisfactory medium of exchange as we do in most other respects?

It is important to be clear at the outset that this is not only politically impracticable today but would probably be undesirable if it were possible.  Perhaps, if governments had never interfered, a kind of monetary arrangement might have evolved which would not have required deliberate control; in particular, if men had not come extensively to use credit instruments as money or close substitutes for money, we might have been able to rely on a self-regulating mechanism.   This choice, however, is now closed to us.  We know of no substantially different alternatives to the credit institutions on which the organization of modern business has come largely to rely; and historical developments have created conditions in which the existence of these institut9ions makes necessary some degree of deliberate control of the interacting money and credit systems (my emphasis).  Moreover, other circumstances which we certainly could not hope to change by merely altering our monetary arrangements make it, for the time being, inevitable that this control should be largely exercised by governments.

Treasury prices are rising across the board (except for maturities six months or less) suggesting that the S&P downgrade is having little or no effect on the markets.  What is affecting the markets is the overall economic outlook which is bad and getting worse.  Now it may be that the sense that economic policy in the US is out of control, which, at least in part, was the basis for the downgrade, is affecting contributing to pessimism about the future, but in that case the downgrade is merely reflecting what the market already was sensing.  But it is not quality of US Treasuries that is the issue.

From today’s New York Times story:

The decision late Friday by the ratings agency Standard & Poor’s to downgrade the United States’s debt rating one level to AA+ from AAA has global implications, said Alessandro Giansanti, a credit market strategist at ING in Amsterdam.

“We can see that this may force the U.S. to move more aggressively to cut spending,” he said, something that could drive the already weak economy into recession and weigh on the economies of all of its trading partners. “That’s the main driver” of the stock market declines, he said.

So the markets are taking fright because they are expecting more draconian cuts in government spending and perhaps increased taxes as part of an upcoming budget deal.  You don’t have to be a Keynesian to understand that slashing government spending and raising taxes precisely when the economy is starting to weaken is not good counter-cyclical policy.  But that is the program that almost everyone in Washington, gripped by a deficit-cutting frenzy, has signed on to.  The idea that we must — MUST — reduce the budget deficit is now wreaking havoc.  With the Fed apparently as paralyzed now as it was in September 2008, we are not in a good place.

Since I started blogging exactly a month ago, I have been arguing that what our weak and faltering recovery needs is a good strong dose of inflation announced in advance by the Fed/Treasury.  The reasoning behind that prescription is that inflation and the expectation of inflation would induce businesses sitting on hoards of cash and households trying to shore up their balance sheets to start spending some of their cash on investments and consumer durables rather than watch the cash depreciate.  Additionally, rising prices, and the expectation of rising prices, would encourage businesses, afraid to expand output and employment because of insufficient demand, to do just that in the expectation that prices would rise sufficiently to allow them to sell the added output at a profit.  Because increased output and employment would, by virtue of Say’s Law, simultaneously create the increased demand to purchase the increased output, there is a very good chance that the leap of entrepreneurial faith encouraged by expected inflation would be self-fulfilling and self-sustaining.

There is another argument for inflation, which I may have already mentioned in passing, but it deserves some further attention, especially after the events of this week.  When the financial crisis turned into a panic in September 2008, it did not take long for Secretary of the Treasury Henry Paulson to propose a scheme whereby the government would buy the so-called toxic assets, largely mortgage backed securities and derivatives of those securities, held by the banks.  Suspecting each other of holding large quantities of toxic assets and therefore of being potentially insolvent, banks stopped lending to each other in the overnight market, causing the entire payment and credit system to break down.  Paulson decided that the only way to loosen up credit was to clear away the toxic assets from the banking system by having the government buy the assets, so that banks would no longer have to worry about lending to potentially insolvent banks in the overnight market.

In the end, the program could not be implemented as planned, because no mechanism could be found to price the toxic assets that the government would purchase from the banks.  Banks, after all, could have sold off those assets at a loss, cleansing their balance sheets, except that doing so would have either precipitated insolvency or made it plain to shareholders how much of their wealth had been dissipated by management error or malfeasance.  Banks insisted that the markets were grossly undervaluing the toxic assets, whose “true” worth was far more than the banks could realize if forced to unload them in a distress sale.  Pleading their case to the sympathetic ears of Secretary Paulson and then Secretary Geithner, the banks succeeded in avoiding being forced to unload the toxic assets on their balance sheets to the government for anywhere near to their market value.  The government, however, was unwilling to pay the banks what they were asking for the toxic assets, so most of the TARP money wound up being used to purchase preferred stock or warrants in banks judged to be at risk of insolvency.  Banks received substantial infusions of government funds with which to recapitalize themselves, thereby avoiding having to book losses on the toxic assets still on their balance sheets.  All in all not a bad outcome from the point of view of the banks.  With a few exceptions like WAMU that were clearly and irretrievably insolvent, banks were not forced into receivership and were not forced to sell any assets at drastic write-downs.

That was not the only largesse directed towards the banks.  In November 2008, the Fed began paying banks interest on their reserves, just as the Fed was reducing its target for the Federal Funds rate to 0.25%.  The interest rate that banks have been receiving on reserves has actually exceeded the rate on 6-months and 1-year Treasury bills almost continuously since December 2008.  Never before in history was holding reserves, which used to be the equivalent of a tax on banks, so attractive.  The resulting expansion of the Fed balance sheet has not monetized the debt; it has merely exchanged Treasury debt previously held by the banking system for generally higher-yielding reserves, providing banks with increased interest income and increased liquidity.

Nevertheless, despite all the goodies showered on them, banks are still burdened with toxic assets on their balance sheets.  Those assets are tied to the real estate market which remains severely depressed, and it now seems even more likely that their prices will fall even further.  There is a good chance that the toxic assets will sooner or later be revealed to be worth close to what markets were offering for them in the darkest days of 2008.  Instead of getting rid of the albatross, banks have held onto them in the hopes of a real-estate recovery that never came.

Why not?  Because the real estate bubble was predicated on expectations of an economic boom with high employment that were not realized.  That was not the only unfounded expectation responsible for the bubble, but it certainly was an important part of the story.  Given that the assumptions on which borrowers and lenders entered into mortgage agreements, it would be reasonable for them to revise the original contracts to allow home owners capable of making reduced payments, perhaps over an extended period of time, to remain in their homes as an alternative to foreclosure.  Mortgage renegotiation has been encouraged, but generally hasn’t worked, because too many separate parties would have to sign off on a renegotiation agreement.

Since renegotiation has not turned out to be practical, the only other method of accomplishing the goal of reducing the unsustainable burden of mortgage debt would be for an outside party to impose a reduction in the value of the debt and monthly payments obviating any agreement by the parties.  One way to do that would be by legislation.  That option has gone nowhere, and is no longer even discussed.  An even simpler and more direct option is inflation.  Increasing prices would increase cash flows and would reduce the burden of outstanding mortgage debt.  Banks would be unhappy, but better off, because fewer foreclosures would mean fewer losses and less expense.  Even if, as I suspect, prices initially rise faster than wages, mortgage payments are fixed, so homeowners would almost certainly come out ahead despite lagging wages.

People often assume that inflation is good for debtors and bad for creditors, while deflation is bad for debtors and good for creditors.  But that holds only if there are no feedback effects from inflation and deflation.  But when deflation increases the burden of real debt and reduces the cash flows available to service that debt, it harms creditors by making too much of  debt they hold uncollectable.  Similarly, inflation can make creditors better off by reducing the debt burden and increasing the cash flows available for debt service.  At this moment, we may well be at a point where creditors, especially banks, have more to gain more from inflation than they would lose.  Similarly, the European Union in general, and even Germany in particular, would likely gain far more from an inflation allowing Greece, Portugal, Ireland, Spain and Italy to pay off their bonds in somewhat depreciated euros than from insisting on ruinous austerity measures that can only lead to the self-destruction of the common currency and perhaps the European Union itself.  Perhaps that is a topic for a future post.

I actually feel uncomfortable doing a day-by-day analysis of how the markets are moving, as I have done for three days in a row.  If I had wanted to be a trader or a market commentator, I would have become one.  And various commenters have correctly pointed out that price movements have more than one possible interpretation.  So it should be understood that all I am doing is adding my own, possibly eccentric, perspective to the mix for whatever it is worth.

With that disclaimer, I will observe that yesterday, the inflation expectations implicit in the TIPS spread on the 2-, and 5-year Treasuries both dropped by more than 10 percentage points, which are pretty significant daily changes, while the implicit expectations on 10-year Treasuries dropped by 9 points.  Interestingly, although the S&P 500 was down for most of the day, it rallied in the afternoon and closed up by almost half a percent.  But the yield on the 5- year conventional Treasuries actually rose by 2 percentage points, so that the implied real return rose a little more than expected inflation dropped.  Even though the market loves inflation, it also likes higher real interest rates, so the real-interest-rate effect, I could argue, offset the effect of declining inflation expectations.  But today the market is again dropping, with rates on the 5-, 10-, and 30-year Treasuries dropping by about 4, 5, and 6 percentage points.  So it seems likely that both real interest rates and inflation expectations are again dropping.  It doesn’t look good to me.

So let me now reply to Lars Christensen (and I hope that he will respond with some cogent observations of his own) who has been arguing that declining inflation expectations are not so ominous, because the Fed has managed to stabilize expectations in the 2 to 2.5 percent range, after having dropped to dangerously low levels last summer before Bernanke,   supported by some key members of the FOMC, decided to initiate QE2.  My concern is that the level of inflation expectations that you need to prevent an asset price crash such as we experienced in September 2008 is not necessarily fixed at a particular level, say 2.5 percent.  In my view, discussed in more detail in my paper on the Fisher Effect, asset prices crash when the expected yield from holding real assets (which one can think of as being represented by the real rate of interest, though this is a huge simplification) is less than the yield from holding money which is the negative of the rate of inflation.  Thus, when asset holders expect deflation, but very little return on real assets, they shift out of holding real assets into money, triggering a decline in asset prices until the expected rate of return on real assets rises enough to make holding real assets preferable to holding money.

This I believe is what was going on, along with a bunch of other bad stuff, in the fall of 2008.  Investors were anticipating falling asset prices concluded that holding money was preferable to holding real assets and there was a crash in asset prices.  The FOMC, instead of counteracting the fall in asset prices by cutting interest rates immediately and flooding the markets with liquidity, sat back and watched happily as the dollar soared in the foreign exchange markets, believing that they had finally broken the back of rising inflationary expectations over which they had been obsessing since commodity prices spiked in the spring.  Job well done.

What I am afraid is happening now is that the expected yield from holding real assets has fallen sharply over the past few months.  Six months ago in early February the yield on a 10-year TIPS bond was 1.39%, so in the last six months the expected real interest rate has fallen by more than 1%.  Just since July 1, the yield has fallen by almost half a percent. There were a number of reasons for this.  Oil prices spiked in February (not because of QE2 as so many now disingenuously allege, but because of the revolt in Libya and other fallout from the Arab Spring) followed by the earthquake and Tsunami in Japan, renewed debt problems in Europe, the farcical soap opera over the debt ceiling that has been playing out in the US, and downward revisions in US GDP, all of which have clouded prospects for future GDP growth to which real interest rates are closely connected.

Now last August when the economy was teetering on the verge of falling into a recession, the stock market declined by about 8 percent before QE2 was announced, the real interest rate on the 10-year bond was just over 1% and inflation expectations were barely over 1.5%.  So if real interest rates have fallen by nearly 1 percent since last August, and expected inflation as measured by the 10-year TIPS spread is 2.28% as of yesterday, I think that we may again be in a danger zone.  I hope that I am wrong.  Lars?

UPDATE:  Well I just saw Lars’s comment on the previous post.  I guess I can’t look for any solace from that source?  Anyone else care to offer some words of encouragement?  Please.

UPDATE II @ 1:12PM EDST:  On Bloomberg, I just saw that gold is now down $15 from its opening today (it was up earlier this morning).  Does that mean that people are trying to get more liquid now?  Query for Ron Paul, when people want to be more liquid, do they prefer holding gold or holding dollars?

After I posted this yesterday at about 3PM EDST, the S&P 500 fell another 10 points in the last hour of trading and the yield on the 10-year Treasury fell another several basis points.  Lars Christensen, in his comment, tried to put a better face on things by suggesting that implied inflation expectations as measured by the TIPS spread had not really moved very much.  That was true on Friday and Monday, but yesterday they dropped sharply.  I use the TIPS spread on the 10-year constant maturity Treasury Bond, which I can only get from the St. Louis Fed with a one-day lag.  However Bloomberg reports the TIPS spread on two and five year Treasuries.  And they both dropped steeply yesterday.  So, despite Lars’s attempt to cheer me up, I am still worried.

This isn’t the first time, and I doubt the last, that I have used a post by Scott Sumner as the basis for one of my own.  But a blogger’s gotta do what a blogger’s gotta do.  Scott is properly worried by the falling yield on the 5-year Treasury.  The entire yield-curve is shifting down rapidly.  The yield on the 10-year constant maturity Treasury, which I follow closely, because I use it in my empirical model correlating movements in the S&P 500 with inflation expectations, has fallen to 2.68%, 30 basis points less than it was last Thursday and 54 basis points less than it was on July 1.  In the meantime the S&P 500 at this moment is down about 40 points since Thursday and 70 points since July 1.

The sharp decline in Treasuries seems to have been triggered by the downward revision real GDP released by BEA on Friday.  As a result, the decline in Treasuries was reflected almost entirely in a decline in the inflation adjusted yield of TIPS-bonds.  Today, however, if I am reading Bloomberg’s quotations correctly, the yields on conventional Treasuries are dropping faster than the yields on TIPS bonds, as they did yesterday, suggesting that inflation expectations are also declining, perhaps explaining why the stock market decline is accelerating today.  Remember the stock market loves inflation.

All of this is starting to get really scary.  The markets obviously believe that the real economy is deteriorating.  They presumably interpret the recent budget deal as a sign of increasing fiscal tightness, but the news story quoted by Scott suggests that the Fed is not at all inclined to provide any new monetary stimulus to compensate for the loss of federal spending.  The dollar is appreciating against the Euro, providing further evidence that inflation expectations are falling.

I really don’t like what I am seeing out there.  HELP!

In an editorial in its weekend edition, The Wall Street Journal, picking up where editorial writer Stephen Moore left off five weeks earlier in his piece touting a report by the Republican staff of the Joint Economic Committee, compares the powerful 1983-84 recovery from the 1981-82 recession with the anemic recovery since 2009 from the 2007-09 downturn.  And guess what?  The Journal finds the present recovery wanting.

No surprise there.  Everyone knows that this recovery is feeble and that, in a very real sense, the Little Depression is ongoing.  But the Journal, of course, wants to teach us a deeper lesson by comparing these two recoveries.  The 1983-84 recovery was presided over by none other than the Journal’s hero, Ronald Reagan, in the full bloom of supply-side economics while the current recovery is the product of the detested doctrines of Keynesian economics embraced by the misguided Barack Obama.

This tale of two recoveries is an object lesson in economic policy. Taking office in 2009, President Obama embarked on one of the greatest reflation bets in history. He deployed the entire arsenal of neo-Keynesian policies to lift domestic demand, much as former White House economist Larry Summers still instructs at Harvard and most of the media still recommend.

So Congress deployed nearly a $1 trillion in stimulus, plus a battalion of temporary and targeted programs: cash for clunkers, cash for caulkers, tax credits for home buyers, 99 weeks of jobless benefits, “clean energy” grants, subsidies to states, and so much more. We were told that every $1 of this spending would conjure $1.50 in new economic output. The Federal Reserve has also more than cooperated by keeping interest rates near-zero for 31 months.

The Journal tells a good story, but the actual data tell a different one.  The revised national income accounts data show that measured as a percentage of GDP, federal spending increased from 20.6 percent of GDP in the fourth quarter of 2007 when the downturn began to 25.4 percent of GDP in the second quarter of 2009 less than six months after Mr. Obama took office.  Since then federal spending has held steady at about 25.5% of GDP.  So most of the increase in federal spending relative to GDP was already in place by the time Mr. Obama took office, reflecting not a significant amount of new spending but rather the contraction of the economy.  A relatively constant amount of spending increases as a share of GDP when GDP shrinks. 

[Added 8/1/11 8:35PM.  I should acknowledge that I overstated my caee here, as one of my commenters noted below.  Federal spending did increase by almost 9% in real terms in the second quarter of 2009.  GDP in the second quarter was just about flat, so it was the increse in spending that accounted for the increasing share of federal spending in GDP.  Of course, without increased federal spending, GDP would likely have been even less than it was.  In addition, since real federal spending during the 1981-82 recession was increasing under Reagan, it is plausible to assume that a substantial portion of the increase in federal spending in the second quarter of 2009 would  have taken place even without Obama’s stimulus program.   So the correct statement is that even without Obama’s Keynesian fiscal policy, the share of federal spending in GDP would have risen to between 24 and 24.5% rather than 25.5%.]

The patterns in the 1981-82 recession and the 1983-84 recovery are instructive in both their similarities and their differences.  In the third quarter of the 1981, the last quarter before the downturn, federal spending as a share of GDP was 21.6%.  When the downturn hit bottom in the fourth quarter of 1982, federal spending as a percentage of GDP was 24.1%.  If the economy had continued to contract, federal spending relative to GDP would undoubtedly have continued to increase.  When the economy did  begin to expand, federal spending relative to GDP declined only slightly under President Reagan, staying over 22% until the last year of his second term, while tax revenues actually declined relative GDP, going down from 19.9% to just over 18%, where they stayed for most of his two terms.

In the 1981-82 recession, the decline in real GDP was about 2.7%; in the 2007-09 downturn, the decline was about 5.1%, nearly twice as much.  In 1981-82 spending as a share of GDP increased about 2.5%, in 2007-09 federal spending relative to GDP increased about 5%, twice as much.  So the Journal has it almost exactly backwards; the rise in federal spending since the downturn in 2007 reflects, for the most part, the depth of the downturn.  It was not, as the Journal bizarrely alleges, a reflation bet made by Obama, much less “one of the greatest in history.” 

So how does the Journal explain the exceptionally slow pace of this recovery?  The Obama administration has frightened businesses and consumers. 

An economy recovering from financial duress [sic] needs incentives to invest again, not threats of higher taxes.  It needs encouragement to rebuild [sic] animal spirits, not rants against “millionaires and billionaires” and banker baiting.  It needs careful monetary management, not endless easing that leads to commodity bubbles and $4 gasoline.

Such an economy also needs consistent and restrained government policy, not the frenetic rewriting of the entire health-care (ObamaCare), financial (Dodd-Frank), and energy (29 major EPA rule-makings) industries.

This is beyond pathetic.  Profits and stock prices have recovered smartly since the economy hit bottom in the second quarter of 2009.  What reason is there to suppose that, if businesses saw profitable opportunities to expand output and employment, they would forego those opportunities because they are afraid that the Obama administration would say unkind things about them?  “Millionaires and billionaires” are always easy targets for politicians, and we have little reason to suspect that they are, as a class, easily intimidated or deterred from doing what they can to further enrich themselves by an occasional unkind remark by a politician, even if he happens to be President of the United States.  And it is simply preposterous to suppose that if businesses thought they could make more profit by increasing output and expanding employment than by streamlining their operations, that they would not choose to make the larger profit, whatever the politicians might be saying.  Does the Journal believe that the business climate is now worse than it was in 1971-72, when Richard Nixon imposed wage and price controls on the entire US economy, railed against the obscene profits of oil companies, and coerced Arthur Burns to open the monetary spigots to fuel a short-lived boom, albeit long-enough lasting to ensure his landslide re-election? 

In 1971-72, rapid monetary expansion was unnecessary for recovery, but effective in achieving the goal for which it was implemented.  In 2011, however, though necessary for recovery, monetary expansion has, appearances to the contrary notwithstanding, not been implemented, banks having been induced by an interest rate almost double that on 6-month Treasury bills to hold all the newly created reserves idle in their accounts with the Fed. 

The Journal accuses Obama’s economic advisers of being unable to explain the failure of their economic policy advice.  Perhaps they are.  But some of us, especially Scott Sumner and, before his untimely passing a year ago, Earl Thompson, have been arguing all along that it was tight monetary policy that got us into this mess, and that monetary policy, despite appearances, had remained tight making recovery impossible.  The malign effects of paying interest on reserves were identified almost immediately, and warnings that the policy would undermine the effectiveness of quantitative easing were issued from the get-go.  Everything that has happened since has confirmed the validity and prescience of the initial analysis of the downturn and of the warnings about how paying interest on reserves would undercut monetary policy to promote recovery. 

The Journal would do well to consider the possibility that there may be other explanations for the Little Depression of the past three years than the simplistic “us vs.them,” “supply-side vs. Keynesian” view of the world seemingly  governing the pronouncements of its editorial page.  Sophomoric outbursts like the one in last weekend’s edition bring no credit to a once venerable journalistic enterprise.

The report issued this morning by the Bureau of Economic Analysis that real GDP grew at only 1.3 percent in the second quarter and revising the estimate of growth in the first quarter down to 0.3 percent is really depressing (pun intended).

This reminds me of 1932.  That’s when the Fed engaged in a program of open market purchases that had at most a minimal effect in slowing the downturn and reversing the slide in prices.  The program was widely dismissed as a failure and evidence of the impotence of monetary policy in a depression.  (Keynes had not yet invented the liquidity trap, but the idea that monetary policy is ineffective in stimulating a depressed economy because the interest rate channel is blocked predates Keynes.  People mistakenly think that Keynes invented the “you can’t push on a string” metaphor, but it seems to have originated with Congressman T. Alan Goldsborough.)  Scott Sumner has written about this episode in his (unfortunately still unpublished) book on the Great Depression, clearing up a lot of the confusion surrounding the program.  It was not until FDR took office in March 1933 and immediately suspended the gold standard, raising the price of gold, that deflation was halted, and reflation and recovery began.

All current monetary policy is doing, intentionally or inadvertently, is inducing banks to hold reserves yielding more interest than Treasury bills.  Looking at the amazing growth in bank reserves and the Fed balance sheet, people are amazed that banks are not lending despite all the “high-powered” money that the Fed has created.  The current policy, like the half-hearted open market purchases of 1932 is a prescription for failure, but the failure is interpreted not as a failure to adopt an expansionary monetary policy, but as a failure of expansionary monetary policy.  In 1933 FDR proved, despite the skeptics, that expansionary monetary policy does work.  Why can’t we learn from FDR?  Where are all the historians of the New Deal?  Why aren’t they pointing out how FDR used monetary policy to start a recovery at the deepest point of the Great Depression?

HT  Benjamin Cole

A few days ago in my posting on gold and ideology, I remarked that gold ideologists like to accuse central bankers of being central planners.  I am not sure when this particular form of rhetorical character assassination got started, but it has become a commonplace of attacks on the Fed coming from the gold party.  A Google search on “central banking” together with “central planning” generates 54,600 results.  Here are some results from the first page.

Robert Blumen, “Will Central Bankers Become Central Planners?” Mises Daily July 31, 2006

Jeff Cooper, “The Fed: From Central Banking to Central Planning.”  Minyanville.com December 8, 2010

Ajay Shah, “Central Banking, Not Central Planning,”  Financial Express October 30, 2009

Richard Ebelling,”Monetary Central Planning and the State.”  Freedom Daily November 1999.

Thomas Dilorenzo, “The Malicious Myth of the ‘Libertarian’ Fed,” Lewrockwell.com, May 8, 2009

Steve Stanek, “We Mocked Soviet Central Planning; Why Not Mock America’s Central Planning.”  blog.heartland.org, April 29, 2011

Michael Brendan Dougherty, “Bernanke Reinvents Central Banking as Central Planning.”  Thedailypaul.com, November 6, 2010

Richard M. Ebelling, “Ninety Years of Central Planning in the United States.” Freemanonline.com, July 7, 2011

Detlev Schlichter, “Nothing Solved.”  ThePaperMoneyCollapse.com  April 28, 2011.

Now I am hardly one who thinks that the Fed does not deserve to be criticized for many sins of commission and omission over the years.  On the contrary, I believe that it bears a heavy responsibility for the Little Depression in which we have been mired for over three years.  But, whatever its faults and mistakes, that hardly makes the Fed a central planning agency.  And there is something disreputable about using a term like “central planning,” with its overtones of totalitarian domination and suppression of individual rights, as a rhetorical bludgeon with which to beat up a person or an institution with whom you have a policy disagreement.

When I remarked that Dr. Judy Shelton had indulged in this of ideological overkill in her recent paean to the gold standard, one commenter, R. H. Murphy, was kind enough to provide a link to a forthcoming paper by Jeffrey Hummel comparing the views of Milton Friedman and Ben Bernanke on the causes of the Great Depression and the appropriate role for monetary policy in general and in countering a severe economic downturn in particular.  I don’t know Hummel’s work that well, so I was pleasantly surprised with what I read.  I learned a lot from the paper, even though, at a theoretical level, it seems to me that Hummel dismisses Bernanke’s concerns about the breakdown of financial intermediation in a depression without sufficiently considering the potential consequences of such a breakdown.  And I would also observe in passing that the paper mistakenly takes Friedman’s view of the causes of the Great Depression as being somehow definitive, when, in fact, Friedman’s explanation misses almost entirely the nature of the monetary disturbance that caused the Great Depression, attaching far too much attention to the bank failures that were just a symptom of a far larger monetary dysfunction rather than an independent cause of the monetary contraction.

But I bring up Hummel’s paper not to comment on Friedman’s explanation of the Great Depression, but because Hummel, in his concluding section, attempts to make the case that Bernanke has gone beyond the kind of central banking that Friedman considered appropriate.   Defending the now much maligned Alan Greenspan, Hummel points out that Greenspan’s approach of flooding the market with liquidity during times of economic distress was not followed by Bernanke in 2008 when the economy was already in the early stages of a financial crisis and in a rapidly worsening recession.  Instead, Bernanke was attempting to provide more sophisticated targeted assistance to the financial sectors experiencing acute distress while keeping the lid tight on overall monetary base.  This is an extremely important observation and a damning criticism of Bernanke.  But even if true, and I am pretty sure that it is, how does that make Bernanke a central planner?  It may make him an interventionist, or even a dirigiste, but that does not make him a central planner.

If you go back to the classical discussions of central planning by Mises and Hayek, you will find that their key point about central planning was that the idea of a central plan is incoherent, because the informational requirements to formulate a central plan were beyond the capacity of an aspiring central planner to satisfy.  In The Road to Serfdom Hayek extended the critique to explain why a serious attempt to implement central planning as an economic system would inevitably lead to a totalitarian political system.  This position has been characterized over the years by Hayek’s critics (and, in their supreme cluelessness, by many of his self-styled supporters) as a claim that any intervention in the economy leads to totalitarianism, a mischaracterization that Hayek always resented and protested against.  But those who call central banking a form of central planning are making exactly the same categorical error about the relationships between intervention, central planning, and totalitarianism to which Hayek took extreme personal offense.

I come not to support central banking, but to defend clear thinking.