“He who tries to borrow ‘money’ needs it solely for procuring other economic goods.” – Ludwig von Mises, The Theory of Money and Credit
As is well-known now, President Trump is conducting a search for the next Federal Reserve Chairman. Naturally this has economists all riled up simply because the Fed employs more of the credentialed than any other entity in the world.
That economists would worship at the altar of what supports their conceit is logical, and can be explained by basic self-interest. What’s less understandable is that Trump’s Fed search has normally right-leaning media all breathy about his choice having some kind of profound economic significance, one way or the other. Apparently the policies of Janet Yellen, a Barack Obama appointee who succeeded George W. Bush appointee Ben Bernanke, engineered economic growth that has “stumbled along at 2%.” Implicit in the latter is that if Trump picks the right central planner, growth will take off. Really?
The Fed conversation has a decidedly 20th century feel to it back when governments thought they could manage economies, but the fact that the U.S. economy remains the envy of the world despite the alleged “2%” rate of growth is a happy reminder that there’s very little planning of economic activity in the U.S., and this includes planning from the Federal Reserve. Economies centrally controlled from the proverbial Commanding Heights are invariably poor, but the U.S. is the richest nation in the world. That the U.S. is so rich exists as a clue as to the truth about the Fed’s economic relevance. It’s well overstated. Whom Trump appoints will be of little consequence despite what pundits want us to believe.
Explicit in the belief that the Fed is economically consequential is that its central plans, if wisely executed, ensure the proper, economy-maximizing flow of credit into the economy. The latter is not a serious view. The Fed can neither expand nor shrink credit, and to see why, readers need only summon a tiny bit of common sense. They need only remember that when we access dollars it’s not the dollars we want as much as we want the goods and services (what Mises referred to as “economic goods”) that dollars can be exchanged for.
We know this because banks in total just aren’t that important anymore as a source of total dollar lending. What’s important is that the Fed cannot engineer an abundance (or a decline) of goods and services we’re either in search of, or seeking to lend out. In that case, the Fed has no ability to control whether credit is “easy” or “tight.” When we borrow we’re once again borrowing access to economic goods, but the supply of those goods is solely a function of productivity in the real economy. Credit is rarely "easy" no matter the Fed's fiddling with its overnight rate target, and despite what people read. Resource access is nearly always a major challenge.
No doubt the Fed can liquefy banks with “money” through purchases of interest bearing assets owned by banks, but then so can any buyer of assets that banks sell to in return for loanable dollars. Assuming the Fed didn’t exist, banks would still be lending, plus they’d still be selling assets in return for loanable funds.
If the Fed were to tighten so-called “money supply,” readers can rest assured that credit would still flow simply because people don’t produce only to sit on their production. Money supply is an effect of production owing to the basic truth that producers use money to exchange the fruits of their toil for what they desire in return for the fruits of their toil. If dollars are scarce, non-dollar replacements will logically find their way to the U.S. to liquefy the trade that is the purpose of all production. Readers should never forget that money was not initially a creation of the state.
Back to banks, they require prominent mention simply because they’re the conduit through which the Fed naively presumes to influence the economy. Yes, the Fed can stimulate bank lending through open market operations, but so once again can any buyer of interest-bearing assets. That banks are the way in which the Fed projects its influence is the next clue that what it does is of little consequence. We know this because banks in total just aren’t that important anymore as a source of total dollar lending (15% as of this writing) in the U.S. economy, plus the previous number is in decline thanks to banks operating under suffocating regulations. So devoid of dynamism is the banking industry that since 2010, only one new banking institution has been incorporated: Bird in Hand Bank in Bird In Hand, PA. If banks were in fact (or if they could be) innovative and profitable, there would be countless new ones opening. That this form of finance is in retreat is a certain signal that the Fed’s always overstated economic influence is similarly in retreat.
That banks and the Fed that projects its influence through them aren’t terribly consequential shouldn’t worry readers. It doesn’t mean that available credit has shrunk. Again, we borrow “money” in order to access real things. So long as production of goods and services is abundant, and so long as Americans continue to be productive in their work output, credit will always be abundant, but at the same time always hard to attain. The Fed quite thankfully can't influence either scenario. The only difference is that the banks the Fed deals with will increasingly not be the intermediary bringing savers and borrowers together. Most credit transactions take place well away from the antiquated banking sector through which the Fed once again presumes to project its waning influence. The banks the Fed relies on for its always overstated relevance have already been replaced for the most part, and by extension so has the Fed been replaced.
Some will say that the Fed’s interest rate policies are still influential, and they’ll trot out the popular notion that the U.S. central bank's aforementioned bond buying influenced interest rates downward in a way that drove investors “into riskier assets like stocks and junk bonds" in recent years. Ok, but the previous view isn’t a serious one. If readers doubt this, they need only ask why equities in Japan, despite decades of central bank engineering meant to bring down interest rates, didn’t similarly soar in concert with the BOJ's machinations.
That there was no rally speaks to why the conventional view of the Fed’s actions is so incorrect. Equity prices aren’t a function of supply vs. demand of same, nor are they driven by vain central bank attempts to be relevant in the credit markets. Seemingly lost in what should be a simple discussion is that equity prices are a reflection of investor perception of the total amount of money a company will earn in the future. Logically. Never explained by those who think economists at the Fed can influence equity prices is why something that’s plainly inimical to economic growth (the central bank borrowing $4 trillion from banks to purchase Treasuries and mortgage-backed bonds) would push the value of equities upward. Equity valuations are once again a perception of future earnings. The QE/stock market correlation is a non sequitur, and a bad one at that.
In a perfect world, the dollar’s value would be unchanging, but that’s another story. And it’s decidedly not a Fed story. But let’s assume what’s ridiculous, that the Fed’s “financial engineering” influenced stocks and bonds from 2009 to the present. If so, this engineering would have had a negative impact on equity and bond prices; a negative impact that would have revealed itself very quickly. To understand why, readers need only remember that equity markets gain strength from periodic weakness much as economies do. Just as healthy economies are defined by emerging businesses innovating existing ones out of business, so do equity markets benefit from the bad being replaced by the good. But if “financial engineering” is artificially driving equity prices up (it’s not, nor has it, but let’s pretend it has for now), that it is signals the propping up of existing businesses at the expense of their more innovative replacements. Ok, but equity markets price in the future, not the present. Assuming engineering could maintain the existing order, the ability to do so would logically be damaging to an economy defined by Schumpeterian dynamism, and by extension damaging to stocks. Stock markets have risen over the years for a lot of reasons, but first and foremost they have because investors see greater odds of corporate growth within what remains a liberalizing global economy. Who knows how long the previous perception will hold, but for now investors are optimistic about the future. That they are signals that the problem hasn’t been 2% GDP growth as much as GDP is a not very accurate measure of economic activity. For one to take 2% GDP growth seriously is for that same person to suggest that equity markets aren’t just stupid, but that they’ve been dumb for quite a while.
Some of course argue that the Fed controls the value of the dollar, and the dollar’s stability as a measure is important. The latter is true, while the former isn’t. The dollar’s exchange rate versus other currencies or gold has never been part of the Fed’s portfolio. Evidence supporting the previous claim is that Fed Chairmen Meyer and Burns begged Presidents Roosevelt and Nixon to not devalue the dollar in 1933 and 1971, only to be ignored by Roosevelt and Nixon in each instance. The dollar’s value is a political concept. Presidents get the dollar they want. If anyone doubts this, they need only consider Alan Greenspan’s tenure as Fed Chairman. The dollar was “strong” against gold and foreign currencies from 1987 to 2001, but it plummeted versus gold and foreign currencies from 2001 to 2006, Greenspan's last years at the Fed. Did his view of the greenback change? No, but policy from the White House did. Upon reaching office in 2001, George W. Bush and his Treasury department made very clear their desire for a weaker dollar. Markets complied, with rather unfortunate consequences as one would expect. The administrations of Ronald Reagan and Bill Clinton were broadly in favor of dollar strength. In a perfect world, the dollar’s value would be unchanging, but that’s another story. And it’s decidedly not a Fed story.
Which brings us to the names being bandied about for Fed Chairman. Yellen and Jerome Powell are seen as the promoters of the status quo whereby their policies will supposedly engineer 2% growth, while alleged "outsiders" like John Taylor and Kevin Warsh will supposedly conduct “monetary policy” in ways that are more conducive to growth. Ok, but Fed policy once again involves dealing with banks that just aren’t that economically important. Furthermore, Taylor’s alleged monetary innovation is to tie the overnight bank lending rate that the Fed targets to the rather misleading (and artificial) calculation that is GDP, while Warsh has publicly defended to Bernanke’s “try everything” approach to crisis in 2008; an approach that wouldn't have worked even if the Fed were powerful as so many assume. Figure that when an economy is recessing, that’s a healthy sign of the boom on the way thanks to the recession serving as the necessary cleanse of all that's holding the economy down. Assuming the Fed were actually capable of fighting recessions as so many who should know better comically believe, they would be fighting recovery. Why Warsh’s service to Bernanke’s inept responses in 2008 adds to his resume is one of those mysteries that begs explanation.
Where Warsh is interesting is that he’s also publicly spoken with great contempt for the notion that the Fed can engineer much of anything. His broad point is that “monetary policy” is not some magical cure. Warsh seems to have learned something from his time watching Bernake despite his honorable (or dishonorable?) decision to not call out this most overrated of thinkers by name. How great if more of his allies on the right were to expand on his point of view, only to acknowledge what’s really true: that the Fed’s dealings with banks aren’t terribly consequential at all, and so isn't the Fed.
If anyone doubts this, they need only consider Greenspan’s Fed tenure once again. The economy boomed from 1987 to 2000, but was a shadow of its former self during his last six years at the Fed. To believe those on the left and right who think the Fed plans economic activity, Greenspan’s policies changed. Not really. What changed was that Greenspan was appointed by Ronald Reagan, a president who largely pursued policies conducive to economic growth: lower taxes, fewer regulations, and a strong dollar. Bill Clinton’s administration generally pursued the same policies. While taxes went up, they were much lower than the rate that prevailed as late as 1986. Better yet, the tax that is government spending fell. A strong dollar that is a magnet for investment was a clear Clinton policy, as was open trade.
The Fed is of little consequence. Readers needn’t care whom Trump appoints. It doesn’t matter. Yet under Bush the tax that is government spending soared, regulations like Sarbanes-Oxley revealed themselves in innovation-sapping fashion, Bush was unafraid to pursue tariffs, plus the dollar went into freefall as previously mentioned. The latter proved a major tax on the investment necessary for economic growth. The U.S. economy reflected the Bush administration’s slow-growth policies. What’s important is that Greenspan and his Fed didn’t change in the 21st century as much as Reagan and Clinton pursued policies conducive to growth, while Bush did not.
Applied to the Fed, its reputation is borrowed. It doesn’t plan economic growth, and it can’t much influence economic growth, so its borrowed reputation is a function of the policies prevalent at the time. In short, Greenspan’s alleged genius in the 20th century was as much of an accident of history as his slightly tattered reputation was in the 21st. Greenspan rode a good policy wave upward, and a bad one downward. If Bush had followed the Reagan/Clinton policy mix Greenspan not only retires a hero, but still is viewed heroically today.
And no, the Fed’s low rate targets in the early 2000s didn’t cause a rush into housing. Please. If true, how do readers explain the 70s housing boom that occurred alongside soaring Fed rate targets? As for the financial “crisis,” it wasn’t caused by Fed rate policies as much as the Bush administration’s interventions in what was a healthy market correction fostered a needless market panic. The Fed caused a crisis only insofar as Greenspan’s replacement, Ben Bernanke, was a prominent voice in favor of the interventions that logically spooked the hell out of investors.
Implicit always in the Fed’s faux legend is that while central planning is always bad, it makes sense from the central bank. Let's try to be serious. The fact that we’re a rich nation is once again a signal of the Fed’s well overstated economic significance. If the Fed were powerful, the economy would forever be weak. But it isn't powerful. The Fed deals with banks that are more and more of little economic consequence. By extension the Fed is of little consequence. Readers needn’t care whom Trump appoints. It doesn’t matter.
Reprinted from Forbes