Wednesday, March 30, 2016

Back When the Federal Reserve Did Some Things Right

In my regular reading, I came across a story of three Federal Reserve Chairmen: William McChesney Martin, chair under Harry Truman; Paul Volker, chair under Ronald Reagan; and our current Dear Leader, Janet Yellen.

The chairmen before Mr. Martin, Marriner S. Eccles and then Thomas B. McCabe,  had to deal with the nation coming out of the Great Depression, entering and then coming out of World War II.  Under the circumstances, the Fed was very accomodative and kept interest rates low, but it was nothing like our last few Fed Chairmen (Allan Greenspan, Ben Bernanke and Janet Yellen).  Martin believed it was the role of the Fed to stay out of things and let a market driven system work.  He believed the role for the Fed should be to counter whatever the economy was doing; to moderate market forces by exerting a little countercyclical pressure.  If the economy was contracting, he thought the Fed should ease conditions to try to get it rolling again.  If it was growing too fast, he thought the Fed should be a resistance.  Perhaps his most famous metaphor was:
The job of the Fed, he said, was to “take away the punch bowl just as the party gets going.” In other words, raise interest rates just when the economy starts to enter an unsustainable boom.
In February of 1951, with the inflation rate running at 8%, President Truman called Martin and the entire Federal Open Market Committee into the oval office to pressure them to keep rates low (turns out "give 'em hell Harry" liked inflating economies as much as later politicians).  Martin refused Truman's "requests" and raised rates from just under 1% to almost 4% at the start of the 1960s.

Twenty years after that, the economy had suffered through the abandonment of the gold standard, transitioning to a fiat currency based on debt, the '70s OPEC oil embargoes, and inflation hitting over 20% at times.  Enter Paul Volker, who saw the need to bring that under control.  But inflation always has friends and cutting it is painful.  In 1980, Paul Volker spoke to the nation:
After decades of inflation, many of us, more or less comfortably, have adapted our business and personal lives to the prospect of more inflation.

We count on capital gains from inflating house and land values as a substitute for real savings. We assume our competitors will match our aggressive pricing policies, and will also accede to high wage demands. We take comfort in our purchases of precious metals, art, and more exotic "collectibles" – or envy those who did buy – and are tempted to project essentially speculative price movements into the great beyond.

But none of this sense of accommodation to inflation can be a valid excuse for not acting to deal with the disease.
To stretch Martin's original metaphor, getting inflation under control would mean taking away not only the punch bowl, but also taking the entire buffet and open bar of money and credit on which the markets feasted.  But Volcker did not back down.  In June 1981, he dosed the economy with a 19.1% federal funds rate; in a few months, the fever was broken. 

Of course, today's situation is unlike that faced by either William McChesney Martin or Paul Volker.  Instead of raging inflation, we have an economy that's in a slow-motion deflation.  Despite creating trillions of dollars in an effort to get growth, all the Fed has been able to do is create an overvalued stock market with inflated prices due to the vast quantities of money available to bid up prices.  The much vaunted Federal Reserve Bank has had about as much effect on the US and world economies as the Bank of Japan and their policies have had on reversing their problems since their stock market collapsed in 1989. 

Janet Yellen is more like Haruhiko Kuroda of the Bank of Japan than either of those previous Fed heads.  In truth, Yellen seems more like an elitist, even collectivist, who thinks she knows better than the billions of transactions that make up the markets.
Where Mr. Martin had insisted that dictating interest rates was “inconsistent with… a private enterprise system,” Ms. Yellen saw no inconsistency at all.

Where Mr. Martin saw the need in a great emergency – World War II – to depart from market-set interest rates, Ms. Yellen is ready to leave the market behind at the drop of the Dow.

And where Mr. Martin and Mr. Volcker both went resolutely about their work, Ms. Yellen seems unsure.

A year ago, she said she would normalize rates “only gradually”… and that, although she had the “macro-prudential regulatory and supervisory tools” to do the job, investors should not expect miracles.

Nor did they receive any. In the 12 months that have gone by since her speech, only 25 basis points (even sparrows refuse to bend to pick up such trivial morsels) is the total of her niggardly gift to savers.
To borrow an old joke, Mrs. Yellen has two chances to fix this: slim and none.  And slim done left the dance already.  Central bankers might be able to make tiny movements of economies, but they seem to be more capable of stopping inflation by shutting off lending than they are capable of starting growth.  If no one is able to buy because they're in too much debt and can't make the payments, it doesn't matter if the interest rate is low. 

The answer, of course, is that economies live and breath.  They expand and they contract like some sort of breathing.  Looked at that way, the central banks are trying to keep the patient inhaling so their lungs expand forever.  That just can't happen.  Cycles end and new cycles start.  At least at some point in history, we had Fed chairmen who realized that it wasn't possible to prevent those cycles and it wasn't even their job.
William McChesney Martin.


  1. This says it all ... "Cycles end and new cycles start. At least at some point in history, we had Fed chairmen who realized that it wasn't possible to prevent those cycles and it wasn't even their job."

    This arm of business maximizing profit at all costs is part and parcel of unbundling all services and charging for everything they can and pushing everything else on the customer/public; stock markets that allow computerized trading transactions with no oversight; zero to negative interest rates making it a fools errand to leave money in a bank. I liken the attempts to eliminate the down trough of cycles like someone trying to speed up human growth by eliminating the natural plateaus that happen after growth spurts. There are reasons the plateaus are needed. And trying to circumvent the "work-in-process" cycle will only result in unintended consequences. But those attempting such can only see $$$$.

    Like those "too-big-to-fail" firms who should be allowed to naturally die for stupidity, it is too bad those trying to short circuit financial/economic cycles are not the sole losers in their fools game. The game of scraping every last penny of profit from everything is like cheapening product designs and brands that have value and legacy. The people doing this care only about one thing and nothing about the world outside of their financial reports.

  2. I'm surprised that you agree with the claim that their is deflation going on; virtually all consumer goods are increasing in price and the only way the CPI doesn't show it is because its inputs are constantly changed to avoid showing inflation.

    1. That's a rough one, but I think that when you scrape off all the inflationary effects of the $trillions in QE and look at what the big picture is, we've already started into collapse. Inflation and collapse aren't mutually exclusive; you can have both. Remember "stagflation" under Jimmy Carter? You had inflation in prices but stagnation in growth. Same thing today only worse. Today we have inflation in prices and negative real growth - collapse. The number of people out of the labor force is exceptionally high, the worst since Carter. I look around our little town and see tons of small businesses going under.

      Only the big banks/big players on Wall Street are doing well. Everyone talks about the difference between Wall Street and Main Street, and they all get it precisely wrong; it's not Wall Street's fault. it's Washington's. Big companies are making themselves look good by buying their own stocks back, which they couldn't do without the zero interest rates. Meanwhile, innovation is slowing, which means those companies are getting worse off.

      It's distortion from the Federal Reserve's ZIRP all the way from top to bottom in the economy.

  3. It's complicated. The Fed 'can' slow or even in some cases prevent a crash. But, should they? A crash allows the weeding out of failing businesses and individuals (I don't mean individuals are 'weeded out literally'). The crash is inevitable but the depth of the crash is the issue. Prolonging the pain by FED manipulation is a mistake. It is done for political reasons and not to help either the people or the economy. We see that today. The crash must be pushed forward into the next administration so that the present administration is not blamed. Clinton did it and Bush would have too but the bubble burst without warming. Let the market cycle. It will be somewhat painful as each down cycle forces businesses to improve their management or go out of business but it is so much better than that big crash when all the can kicking no longer puts off the inevitable.

  4. A central bank is not a regulator, it's an oscillator. Even when the sign of the feedback is correct, there is too much delay before the feedback is applied. Perhaps you could construct a Spice model of the US central bank in 1950. If it's predictive enough you could then reject the nondisprovable "it's complicated" waffles.

    I've heard that Britain during the reign of Queen Victoria did not have a "business cycle", because Victoria used a gold standard. Business cycle before Victoria and after, but not during. This means it's not the "business" cycle, it's the "official counterfeiters'" cycle.

    The effect of a central bank/currency printer is to prevent discovery of the proper value of money, which is measured by the prime lending interest rate.