Thursday, August 25, 2011

The Fed's Philosopher King

Having one man control the money supply of 311 million Americans is itself a fantastic and unreal notion. When you then consider the effects of the U.S. Dollar on the remaining 6.6 billion people on this planet, the idea becomes unimaginable.

Meet Ben Bernanke: the dollar's whimsical "Philosopher King," and the Chairman of the U.S. Federal Reserve. He is arguably the most powerful person in the world, with powers far surpassing those imagined when his position was created. Who knew the Fed Chairman could become so influential?

Well, perhaps there are some who foresaw the potential. In the Communist Manifesto, Karl Marx listed ten absolute principles for overturning capitalism. Number five on his list is the most relevant when discussing the Federal Reserve: "Centralization of credit in the hands of the state, by means of a national bank with State capital and an exclusive monopoly."

Even the early Communists acknowledge this as a path to destruction, to say nothing of the Founders. Who does King Ben answer to? He is not an elected official. Where does a man who makes multi-trillion dollar bets and has control of the world reserve currency and its printing presses get such authority?

Chairman Bernanke only indirectly answers to the President. He can be impeached for a crime, but not for incompetence. The President appoints the Chairman, but once confirmed neither the Federal Reserve Chairman nor the Federal Reserve Governors can be removed for their policy views. So, like a union worker, the Federal Open Market Committee (FOMC) can't be fired. All the Chairman has to do to get reappointed is help get the President reelected.

If you think the rest of the FOMC has any oversight on the Chairman, think again. As the anointed "sun king of currency," no Federal Reserve Chairman can long tolerate discord in his ranks. The pressure for the FOMC members to follow the lead of the Chairman is immense.

Granting the power to print an unlimited amount of paper "money" to one unelected individual is like playing monetary Russian roulette with a Glock. Have we forgotten that Sir Alan Greenspan is now criticized for policies that led to the subprime collapse, including keeping Fed Funds at 1 percent for over a year at the start of the contagion? But no one says a harsh word about the current Chairman for keeping Fed Funds at zero for 33 months and promising to maintain zero Fed Funds for "at least two more years," even though the National Bureau of Economic Research (NBER) claims the recession officially ended two years ago (June 2009).

Who wins from this structure? The government of course, because they borrow more money than anyone else, just ahead of the Fortune 500 companies and Wall Street traders and speculators. The losers will be savers -- those on fixed incomes, the middle class, and of course the global poor, who will suffer most because of inflationary increases in the cost of basic foods and fuel.

The Federal Reserve's rationale for focusing only on the seasonally adjusted "core rate" of the CPI is a complete sham, designed to obscure reality. The core rate weighs "wage increases," but, unlike the gross number, does not factor in food and energy. Wage increases, like employment, are "lagging" events. For the record, inflation is only a monetary event.

The Federal Reserve's current policy of "negative real interest rates" amounts to outright stealing. For example, the historic spread since 1926 between the CPI and Treasury bill rates is 63 basis points. The last reported CPI was 3.6 percent, which would put an appropriate T-Bill rate at 4.23 percent; add in the typical 25 basis-point spread between T-Bills and the Fed Funds rate and you get 4.55 percent. That is about what the Fed Funds rate should be today. Instead, Fed Funds are 0.25 percent and the T-Bill rate is around 0.03 percent, or 3 bps. The way things stand, savers are losing over 4.5 percent annually.

Some people claim that the zero interest rate policy (ZIRP), combined with printing countless billions of dollars in paper money, is leading to economic growth. If so, where are the jobs? Where is the GDP growth? Keynesians retort that there is a lack of "aggregate demand." Strange that there is no lack of "aggregate demand" for the new iPad.

Jean-Baptiste Say (1767-1832) is generally credited with the creation of what is referred to as "Say's Law" -- the original version of what has developed into modern "supply-side" economics. The basic tenet of supply-side economics is that the level and extent of aggregate demand is a function of the long-term trend of innovations and new inventions. That trend is a direct function of the demand for workers and their productivity.

The number of workers demanded, and their productivity, in turn depends on the rate of capital investment by the private sector, which is caused by market demand and the quantity of innovations and inventions. These new products are driven -- like almost all human endeavors -- by incentives, and by a group of risk takers called entrepreneurs. These entrepreneurs are generally supplied with capital by a similar group of risk takers called venture capitalists, who measure each entrepreneurial opportunity as a ratio of risk to reward. These two groups thrive in direct proportion to the level of economic freedom, tax rates, and regulatory interference found in a nation.

Remember the internet and dot-com boom in the mid-1990s? Say's Law operated with great results. Supply created demand as eBay, Yahoo, Amazon, Google, and many more great businesses flourished. Huge wealth expansion resulted for all, while the growth in profits and increased tax revenue created by these innovators helped balance the Federal budget. In the same period, Main Street saw 4 percent real GDP growth while employment increased across the board.

Now we need to return to an atmosphere of 1990s-style innovation, but be even more vigorous. This can only be done with private investment and an atmosphere of acceptable risk. It cannot be accomplished by borrowing 40 cents or more of every dollar spent by the government, maintaining zero interest rates, and devaluing the real U.S. Dollar by printing massive amounts of fiat paper money via a central bank under the banners of "quantitative easing" and "stimulus." These government methods always fail because they are temporary and extremely expensive.

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