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Well-Deserved Scrutiny For The Fed

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In the wake of the 2010 elections, it’s difficult to find a pundit who doesn’t mention the Tea Party at least once while discussing the results.  This got me thinking about whether the man referred to as “The Godfather” of the Tea Party movement, Congressman Ron Paul (father of Tea Party candidate, Senator-elect Rand Paul) will become more influential in the next Congress.  More important is the question of whether Ron Paul’s book, End The Fed will be taken more seriously – particularly in the aftermath of the Fed’s most recent decision to create $600 billion out of thin air in order to purchase even more treasury securities and mortgage-backed securities by way of the recently-announced, second round of quantitative easing (referred to as QE2).

The announcement by the Federal Open Market Committee to proceed with QE2 drew immediate criticism.  The best rebuke against QE 2 came from economist John Hussman, whose Weekly Market Comment – entitled, “Bubble, Crash, Bubble, Crash, Bubble …” was based on this theme:

We will continue this cycle until we catch on.  The problem isn’t only that the Fed is treating the symptoms instead of the disease.  Rather, by irresponsibly promoting reckless speculation, misallocation of capital, moral hazard (careless lending without repercussions), and illusory “wealth effects,” the Fed has become the disease.

One issue raised by Mr. Hussman – which should resonate well with supporters of the Tea Party – concerns the fact that the Fed is undertaking an unconstitutional exercise of fiscal policy (rather than monetary policy) most notably by its purchase of mortgage-backed securities:

In this example, the central bank is not engaging in monetary policy, but fiscal policy.  Creating government liabilities to acquire goods and assets, unless those assets are other government liabilities, is fiscal policy, pure and simple.

Hussman’s analysis of how the “the economic impact of QE2 is likely to be weak or even counterproductive” was best expressed in this passage:

We are betting on the wrong horse.  When the Fed acts outside of the role of liquidity provision, it does more harm than good. Worse, we have somehow accepted a situation where the Fed’s actions are increasingly independent of our democratically elected government.  Bernanke’s unsound leadership has placed the nation’s economic stability on two pillars:  inflated asset prices, and actions that – in Bernanke’s own words – should be “correctly viewed as an end run around the authority of the legislature” (see below).

The right horse is ourselves, and the ability of our elected representatives to create an economic environment that encourages productive investment, research, development, infrastructure, and education, while avoiding policies that promote speculation, discourage work, or defend reckless lenders from experiencing losses on bad investments.

On November 6, another brilliant critique of the Fed came from Ashvin Pandurangi (a/k/a “Ash”) of the Simple Planet website.  His essay began with a reminder of what the Fed really is:

The most powerful, influential economic policy-making institution in the country, the Federal Reserve (“Fed”), is an unelected body that is completely unaccountable to the people.

*   *   *

The Fed, by its own admission, is an independent entity within the government “having both public purposes, and private aspects”.  By “private aspects”, they mean the entire operation is wholly-owned by private member banks, who are paid dividends of 6% each year on their stock.  Furthermore, the Fed’s decisions “do not have to be ratified by the President or anyone else in the executive or legislative branch of government” and the Fed “does not receive funding appropriated by Congress”.  In 1982, the Ninth Circuit Court of Appeals confirmed this view when it held that “federal reserve banks are not federal instrumentalities … but are independent, privately owned and locally controlled corporations”.

As we all know:  “Absolute power corrupts absolutely”.  At the end of his essay, Ash connected the dots for those either unable to do so or unwilling to face an ugly reality:

In the last two years, the almighty Fed has printed trillions of dollars in our name to buy worthless mortgage assets from “too big to fail” banks.  It has lent these banks our hard-earned money at about 0% interest, so they could lend our own money back to us at 3%+.  These banks also used our free money to ramp equity and commodity markets, which mostly benefited the top 1% of our population who owns 43% of financial wealth [2], and conveniently, also owns the Fed.  The latter has kept interest rates at next to nothing to punish savers and encourage speculation, making everything less affordable for average Americans who have seen their wages stay the same, decrease or disappear.  What’s left standing is the perniciously powerful, highly secretive and entirely unaccountable Fed, who now epitomizes the state of American democracy.

At least we still have freedom of speech!  As part of the Fed’s roll-out of QE2, Chairman Ben Bernanke found it necessary to write a public relations piece for The Washington Post – perhaps as an apology.  Stock market commentator Bill Fleckenstein had no trouble ripping Bernanke’s article to shreds:

Bernanke goes on to say:  “Although low inflation is generally good, inflation that is too low can pose risks to the economy — especially when the economy is struggling.  In the most extreme case, very low inflation can morph into deflation.”

Oh, yeah?  Says who?  I have not seen any instance where a “too low” inflation rate led to deflation.  When deflation is caused by new inventions or increased productivity (or in the old days, bumper crops), which we might term “good” deflation, it was not a consequence of too little inflation; it was due to progress.  Similarly, the “bad” deflation isn’t created via inflation that is too low; it tends to come from burst bubbles.  In other words, misguided policies, not low inflation, are the cause of deflation.

Because the timing of the Fed’s controversial move to proceed with QE2 dovetails so well with the “energizing” of the Tea Party movement, it will be interesting to observe whether life will become more uncomfortable for Chairman Bernanke.  A recent article by Joshua Zumbrun of Bloomberg News gave us this hint:

Six out of 10 self-identified Tea Party supporters who said they were likely to vote supported overhauling or abolishing the Fed, according to a Bloomberg News national poll conducted Oct. 7-10.

The article made note of the fact that Ron Paul’s ill-fated effort to Audit the Fed (HR 1207) received bipartisan support:

“You had a really strange alliance last year that supported the audit of the Fed and that may come back into play,” said Dean Baker, co-director of the Center for Economic and Policy Research in Washington.

Here’s to bipartisanship!


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