All Commentary
Wednesday, September 21, 2011

The New Fed

“Things are seldom what they seem.”
—W. S. Gilbert, “H.M.S. Pinafore”

Nowhere is this more true than in government, which means we have to watch it closely. Unfortunately preconceived notions can make us impervious to events right in front of us and lead us to colossal misperceptions.

Take the Federal Reserve System. (All together now: Please!) Since the central bank controls the money supply, advocates of free markets and market-based money are understandably wary of its power to generate inflation. It’s inflated in the past and has the capacity to do so in the future. So attention naturally goes in that direction.

The problem is that while we’re watching for inflation, we might be missing the Fed’s real mischief elsewhere. In stage magic this is called misdirection.

Jeffrey Rogers Hummel, a macroeconomist at San Jose State University and a Freeman contributor (not to mention an old friend), says that’s exactly what has been happening. While inflation hawks have been busy looking for any sign, or even any word, of monetary expansion, Hummel writes, “[Fed chairman Ben] Bernanke has so expanded the Fed’s discretionary actions beyond merely controlling the money stock that it has become a gigantic, financial central planner.”

In other words, “Bernanke’s targeted and sterilized bailouts have altered the fundamental nature of the Federal Reserve. . . . [T]he Fed that emerged from the [housing and financial] crisis is no longer the same as the Fed before the crisis. . . . Most economists appear not to appreciate fully how drastic the changes are that Bernanke has wrought.”

Note the word “sterilized.” That means the Fed’s huge bailout program has been carried on largely without creating net new money. And that makes the Fed a menace to markets even when it’s not generating inflation! Hummel says that what we should be concerned about today with respect to the Fed is not inflation but central, nonmarket control of the allocation of scarce capital. In our obsession with inflation, we are missing an ominous leap further into corporate statism.

Hummel spells this all out with admirable clarity and detail in “Ben Bernanke versus Milton Friedman: The Federal Reserve’s Emergence as the U.S. Economy’s Central Planner,” published in Freeman columnist Robert Higgs’s great quarterly journal, The Independent Review, Spring 2011.

Bernanke’s efforts to channel capital to particular firms and sectors, including insolvent financial institutions, are breathtaking in scope. Previous Fed chairmen, notably Alan Greenspan, poured new money into the economy in response to anticipated crises, but they did not attempt to direct the money to chosen destinations. That was left to the market (however distorted). Things are different now. Bernanke directs the flow of credit—and has been doing it generally without creating new money.

How so? By selling assets to or borrowing money from banks and other institutions. Follow the money: When the Fed sells assets (T-bills, mortgage-backed securities, whatever) or borrows, it takes money out of the economy. If it turns around and lends the money to a bank, the impact on the money stock is a wash. However, the Fed has acted like a central planner of the capital market. Hummel leaves no doubt that this is what the Fed was up to before September 2008.

After that the Fed appeared to create huge amounts of new money through what has been called “quantitative easing” (QE1 and then QE2). But since 2008 it has also paid banks interest on reserves kept in their Fed accounts. “Bernanke in effect created money and then borrowed it back from the banks by paying them interest. . . . [T]he payment of interest on reserves was tantamount to borrowing back from depositories the full $800 billion increase in reserves and more. No wonder the impact of the base explosion on the broader monetary measures (except for M1) was so muted,” Hummel writes.

Summing up, Hummel says, “Helicopter Ben talks a good line about being ready to unleash quantitative easing, but this talk only imparts an aura of justification for the Fed’s incredibly expanded role in allocating the country’s scarce supply of savings. If anything, his policies were closer to a quantitative tightening. A better moniker would therefore be ‘Bailout Ben.’”

* * *

The Progressive Era’s infatuation with regulation of labor markets is typically portrayed as a humanitarian impulse. But could darker motives have been at work? Art Carden and Steven Horwitz have evidence to support that suspicion.

During last summer’s debt-ceiling controversy Fed Chairman Ben Bernanke made a remarkably anti-Keynesian concession that undercut his own monetary policies. James C. W. Ahiakpor has the scoop.

The government now will pay people—possibly a lot—to blow the whistle on the companies they work for. One need not believe that business is faultless to see the dangers in this government-created incentive. Warren Gibson spells it out.

Arthur Koestler’s classic novel about the horrors of the Soviet Union, Darkness at Noon, was published 70 years ago this year. Edward Bruce Walker has a tribute to Koestler and his unique book.

Classical liberals like Arthur A. Ekirch, Jr., and George C. Roche III, as well as Progressives, were critics of the Gilded Age. Joseph Stromberg thinks they were onto something.

One of the most influential journalists of the twentieth century was Walter Lippmann, an establishment figure who mostly took wrong positions on economic policy. But for a brief period he was struck with free-market insights about the impossibility of central planning. Harold B. Jones, Jr., has the details.

Bureaucratic central decision-making is notoriously bad because it ignores what F. A. Hayek called “the knowledge of the particular circumstances of time and place.” Paul Schwennesen applies this principle to two seemingly dissimilar cases.

Here’s what our ever-curious columnists have cooked up this issue: Lawrence Reed pays attention to the sadly neglected Samuel Smiles. Robert Higgs takes a scalpel to Lyndon Johnson’s War on Poverty. Thomas Szsaz focuses on a degraded and disfavored class of Americans. John Stossel exposes the scam of college. Charles Baird traces crony unionism in the government sector. And Arthur Foulkes, reading that claim that America can be great only through big government, responds, “It Just Ain’t So!”

Books coming under our reviewers’ microscopes cover so-called great leaders, the Mont Pelerin Society, state nullification of federal law, and the relationship between science and liberal democracy.

—Sheldon Richman
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  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.