Bernanke and Greenspans Pretense of Economic Knowledge Continues
Economics / Economic Theory Nov 15, 2010 - 09:46 AM GMTBy: Douglas_French
Two years after the Wall Street '08 come-apart, with the economy still lingering in a funk, the Federal Reserve announced, a day after the elections, what the Associated Press called "a bold effort to invigorate the economy": the purchase of $600 billion of government bonds from now through the middle of next year, at a pace of $75 billion a month. This $600 billion is on top of the $250–$300 billion the Fed will be buying to reinvest proceeds from its mortgage portfolio.
"The idea is for cheaper loans to get people to spend more and stimulate hiring," says the Associated Press. "The Fed says it will review whether adjustments are needed depending on how the economy is performing."
The Fed's Open Market Committee press release states,
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
Yes, I know even Sarah Palin is outraged. She's calling for Ben Bernanke to "cease and desist" (I wonder if she can see him from her backyard), but this $600 billion comes after an unprecedented $8 trillion in federal-government power has already been unleashed through actions by the Federal Reserve, the TARP, guarantees made by the FDIC, and other direct bailouts. The federal-funds rate has been between 0 and .25 percent since December 2008.
And the results of all that?
At the end of October 2008, the yield on the government's 10-year bond was 3.92 percent. It ended last week yielding 2.52 percent. Lending your government money for one year snagged you all of 21 basis points last week. Two years ago you would earn for the same duration a comparatively fat 1.44 percent.
The Prime Lending Rate that banks base their commercial-loan rates on was slashed to 4 percent in October of 2008, less than half the 8.25 percent prime that borrowers had been paying a little more than just a year earlier. Banks then cut their prime rates even further two months later, in December 2008, to 3.25 percent.
Thirty-year fixed-rate mortgages were 6.87 percent the week of October 31, 2008. A couple weeks ago, the rate was more than 200 basis points less at 4.58 percent.
So I've got news for the Associated Press: interest rates are already down, but banks aren't lending the money and borrowers aren't borrowing. Total bank loans were down $96 billion at the end of the second quarter. Commercial and Industrial (C&I) loans totaled over $800 billion in 2008; now it's just over $600 billion. C&I loans are business loans taken out for expansion and short-term cash-flow needs. If businesses aren't borrowing, they likely aren't hiring.
Consumers aren't borrowing either. Consumer indebtedness was down $110 billion from the end of June, reports Bloomberg. Households have slashed about $1 trillion from outstanding consumer debts since the peak in the third quarter of 2008, according to the New York Fed.
And while interest rates have fallen, unemployment has risen. In October of 2008 the unemployment rate was 6.1 percent. Now it's 9.6 percent. If you count discouraged workers and those forced to work part-time, the unemployment rate is 17 percent. There were 1.2 million discouraged workers in September — more than double the 503,000 from this time a year ago.
The average length of official unemployment has increased to 24.5 weeks, the longest since government began tracking this data in 1948. The number of long-term unemployed (i.e., for 27 weeks or more) has now jumped to 4.5 million, an all-time high.
And nearly 1.5 million of the unemployed have been out of work for 99 weeks.
GDP is reportedly growing at 2.5 percent, but John Williams at Shadowstats reports that 63 percent of that is from inventory building, despite reports that consumption is slowing. However, Williams writes,
If the quarterly GDP growth were viewed in terms of just quarter-to-quarter change — the way the rest of the world tends to report GDP — that nonannualized quarterly growth rate in final sales would round to 0.1%, which is minimal growth, virtually flat, by most any standards.
In August, over 42 million Americans were participating in the government's Supplemental Nutrition Assistance Program (SNAP). In other words, 42 million people are buying their groceries with food stamps, an all-time record and a 17.5 percent increase from July of last year.
So all of this rate cutting and monetizing hasn't put anyone to work or stabilized anything other than dependence on the government. And while the folks at the Bureau of Labor Statistics say that price inflation is virtually nonexistent at a 1.14 percent CPI, John Williams, who calculates CPI the way it used to be done, says consumer prices are rising at nearly 8.5 percent.
All this money and government stimulus, and no growth and no jobs to show for it.
Only prices are rising, even if the government says they aren't. The "stimulus" hasn't worked.
But Keynes said a little (or a lot of) government nudge here and there would bring prosperity. After all, he claimed that markets were broken and it was for government and central banks to intervene. As Hunter Lewis summarized in his book Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts, it was Keynes's contention (in addition to us all being dead in the long run) that
- people are too future oriented;
- society tends to underconsume and oversave;
- interest rates tend to be too high;
- monetary policy can lower interest rates by money printing; and
- Keynes's core theory, "unused savings … interrupt the flow of money through the economy and lead to unemployment. Unemployment reduces society's income."
So the Keynesians contend it's not a matter of if their policies will work; it's only a matter of when. And if Keynesian monetary stimulus hasn't worked so far, it's because the Fed hasn't done enough.
Nobel prize winner and Grey Lady columnist Paul Krugman is underwhelmed by Bernanke's announced printing. QE2 is "Meh," he writes. He says $600 billion isn't diddly when you're trying to turn a $15-trillion battleship.
Now, if he were King Bernanke he'd make a commitment to achieve 5 percent annual inflation over the next 5 years — or, perhaps better, to hit a price level 28 percent higher at the end of 2015 than the level today. (Compounding) Crucially, this target would have to be non-contingent — not something you'll call off if the economy recovers. Why? Because the point is to move expectations, and that means locking in the price rise whatever happens.
Most Keynesians think we should all thank our lucky stars for their policies already.
Economists Alan Blinder and Mark Zandi did a report recently supposedly using a "standard economic model" and determined that if the Fed hadn't intervened the decline in GDP would have been three times worse, the unemployment rate would have risen to over 16 percent, and we would have had a federal deficit of $2.6 trillion.
If the model is so "standard," then, as Bill Bonner points out, how come the Obama economic team (since surely Larry Summers and Christina Romer had a standard model stuffed somewhere in their desks) was claiming that the initial stimulus would ensure that the unemployment rate wouldn't climb over 8 percent?
It turns out this modeling business is all nonsense.
F.A. Hayek explained in his 1974 Nobel Prize acceptance speech, entitled "The Pretense of Knowledge," that monetary and fiscal policies are the product of what he called the "scientistic attitude," which is in fact unscientific in that it "involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed."
Just as they did 36 years ago, when Hayek delivered this seminal speech, the Keynesians today believe there "exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level."
So while Bernanke — with Paul Krugman looking over his shoulder and telling him where to put the paddles and how many volts to shock the patient with — thinks he can crunch the data, make a diagnosis, concoct the right monetary witch's brew, and inject lots of it to make us all employed and living happily ever after, the fact is that's impossible.
In the physical sciences, that may work; but, as Hayek explains,
such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process … will hardly ever be fully known or measurable.
The wise ones at the Fed and Treasury are only looking at factors that can be quantitatively measured; they disregard any factors that can't. Thus, as Hayek would say, "they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant."
No single observer could know all the factors determining prices and wages in a well-functioning marketplace. But because policy makers think they know, "an almost exclusive concentration on quantitatively measurable surface phenomena has produced a policy which has made matters worse," Hayek said back in 1974.
Nothing has changed.
James Grant explains in a recent Grant's Interest Rate Observer,
The trouble with living authorities in money and banking is the ideas they absorbed in school. For instance, that a central bank can calibrate the rate of debasement of the currency it prints by adjusting the speed of the digital press. Or that the Federal Open Market Committee can pick the interest rate that will cause the GDP to grow and payrolls to swell and prices to levitate by 2% per annum, give or take a basis point. Such things are impossible.
Ben Bernanke presumably thought cutting the federal-funds-rate target to "zero to a quarter" and nearly tripling his employer's balance sheet from $800 billion to over $2.2 trillion would put everyone who wanted to be not only back to work but swiping their plastic for a new big-screen TV or maybe taking advantage of GM's 0 percent, 60-month financing to drive a new Acadia Denali off the lot.
However, Hayek explains,
It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences — an attempt which in our field may lead to outright error.
Bernanke and company are making errors aplenty by endlessly inflating and bailing out dysfunctional firms. And continuing that theme, the Fed's proposed QE2 bond purchases will come from the middle of the yield curve, with two-thirds of the purchases to be notes with durations of 4 years to 10 years, according to the New York Fed.
It is the nation's big banks that will benefit from QE2 as they pay their customers zero for deposits and buy Treasuries yielding 1–2 percent, knowing the Fed has their back. No loan-loss reserves must be retained if the bank is lending to Uncle Sam — as opposed to if the bank lends to your cousin Sam to start a business or buy a house.
So while the Fed thinks more money means more employment, the real result of all this stimulating will be more unemployment, not less. Frank Shostak explains that QE2 undermines capital formation, and less capital formation in turn weakens economic growth.
And the poorer people are, the higher their time preferences. "A so-called lowering of 'real' interest rates by means of money pumping is basically an act of a diversion of real wealth from wealth generators to various nonproductive activities," Shostak explains. "Hence, contrary to popular thinking, the Fed's attempt to lower the real interest rate in fact leads to a higher real interest rate."
The reason we have a recession is that it is a clearing of the malinvestments that the Fed's easy money went into during the boom. So, "[p]roducing things that nobody wants and propping up malinvestments cannot possibly help any economy," writes economist Ben Powell.
The government's moneymen are engaging in what Hayek referred to as "the fatal conceit," thinking they have the knowledge to fix and plan the economy. "If man is not to do more harm than good in his efforts to improve the social order," Hayek lectured,
he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible.
But these Fed chairmen are considered the most powerful men in America, if not the world.
While on the job, previous Fed chair Alan Greenspan was reverently referred to as "the Maestro." However, as Lew Rockwell points out,
Monetary pumping was his one weapon. Think of the occasions: the Mexican debt crisis of 1996, the Asian Contagion of 1997, Long-Term Capital Management in 1998, the Y2K crisis of 1999 and 2000, the dot-com collapse, and finally the 9-11 terrorist incidents in Washington and New York.
Greenspan now must spend his time reinventing history and denying any accountability for his Fed's monetary policies. Even that Enron prize he won doesn't look so hot.
The current Fed chair was Time magazine's Person of the Year last year because "[h]e didn't just reshape U.S. monetary policy," Time's Michael Grunwald gushes, "he led an effort to save the world economy."
However, Bernanke's reputation may have hit its peak at the end of '09. The harder he hits the monetary gas pedal, the faster his reputation — along with the value of the dollar — goes downhill.
And while the self-confidence of central bankers knows no bounds, there's no telling where the money they create will go or what it will do. "All monetary policies encounter the difficulty that the effects of any measures taken," wrote Ludwig von Mises, "can neither be foreseen in advance, nor their nature and magnitude be determined even after they have already occurred."
In 1936, Henry Parker Willis wrote in The Theory and Practice of Central Banking,
No central bank can, by the mere exercise of its credit-granting power, make something out of nothing, or save other banks from the disastrous consequences of their past policy. When a central bank does so it merely tends to make a bad matter worse.
Willis, who, by the way, was the first secretary of the Federal Reserve Board, wrote back in a time when central banks were thought to merely be available to liquefy the commercial-banking system. Today, Fed heads and their committees are thought to be benevolent clairvoyants who can wave their magic interest-rate wands, growing aggregate demand and putting the masses back on the job.
Even back in 1936, Willis foresaw that central banking would become a tool of politicians to placate the discontent of the citizenry. "In such cases," he wrote, "central banking becomes merely an adjunct to a dynasty of political dictators who desire to bring about an artificial redistribution of purchasing power and wealth."
Concluding his Nobel acceptance speech, Hayek said,
The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society — a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.
While the wisdom of Hayek is long forgotten, we have instead central bankers who are worshiped on Wall Street and in Washington, allowing their hubris to place not only the US economy but all of society on the brink of destruction.
Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. See his tribute to Murray Rothbard. Send him mail. See Doug French's article archives. Comment on the blog.
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