BEN Bernanke has begun the next phase of the US Federal Reserve Bank’s currency war on the rest of the world.
A renewed bout of US dollar debasement is bad news for Asia and the rest of the global economy. The chances are that the consequent financial instability will ultimately damage confidence, crimp job-creating investment and cause dislocation in Asia and other currency and stock markets.
Reacting to yet more volatility on Wall Street, the chairman of the US Federal Reserve Board and his committee made the extraordinary decision of pegging interest rates at almost zero until well into 2013. Such a policy hardly generates confidence in the greenback despite the mealy-mouthed words of Fed officials and US Treasury Secretary Tim Geithner, who all claim that they support a strong dollar.
Not surprisingly, gold has risen to record heights and the greenback has begun to weaken. If Bernanke’s latest wheeze of punitively low rates fails to generate higher job-creating exports from further greenback devaluation and ignite the flat US economy, the third round of quantitative easing (QE3) is on the cards.
We are now some 14 months away from the November 2012 presidential elections. The not-so-independent chairman of the Fed (who was dubbed ‘Helicopter Ben’ for wanting to drop US dollar notes from high to forestall a depression) precipitated QE2 last year ahead of the Congressional elections.
It would thus be surprising if he didn’t help beleaguered President Barack Obama obtain a second term. For the shrinking minority who still believe the Fed’s claim of independence, Obama is expected to announce more Keynesian public-sector spending to stimulate the economy. A third dose of quantitative easing would add to the mountain of money that is available for banks. The hope is that they will then lend more and avert any possibility of the recession that several leading economists are currently predicting.
The latest policy move of the Fed comes from a long line of Fed failures since its inception in 1914. Recent polls show that Bernanke’s Fed is even more reviled in the United States than the Internal Revenue Service. If there were a competition, the latest incumbent would be a favourite to win a competition of the worst chairman ever out of the sorry lot.
In a fascinating book, The Global Curse Of The Federal Reserve (Palgrave MacMillan), Brendan Brown, the London-based head of economic research at Mitsubishi UFJ Securities International, narrates the wrong-headed decisions of Fed governors during the past 100 years.
Such is Brown’s despair about Fed failures that his book is a Manifesto For a Second Monetarist Revolution. In essence, this is a proposal that the US Congress should stifle the celebrity status and power of the Fed bureaucrats.
Congress should enforce a regulatory framework that requires the Fed to pursue responsible monetary policies. Brown’s proposal is that following advice from monetary experts, Congress should set a monetary base of Fed reserves that should have steady growth. In effect, the system would be a modern version of the gold standard whereby a proportion of reserves of banks would be deposited at the central bank. The banks would receive no interest on their deposits at the Fed.
Interest rates in the money markets and hence overdrafts and mortgage rates would rise and fall according to market conditions. Closeted bureaucrats at the Fed would no longer target interest rates which arise from the current payment of interest on banks’ reserves at the central bank. In a boom, rates would rise and curb consumer inflation and speculation in property, shares, commodities and other assets. In the subsequent downturn, rates would fall. No longer would Fed officials, who have had a shocking track record in predicting the economy, dictate the level of interest rates at wrong times.
A regulated, target monetary base, independent of Fed governors’ whims, would not end boom and busts, Brown says. But it would reduce the amplifications and potential monetary dislocation, and also counter currency debasement.
The big question is whether Congress would agree to such a system. Brown believes that the Republicans are already in revolt against the dangerous monetary management of Bernanke. In the event of another financial crisis it is very possible that a Republican Congress would seek change, he writes. So far, however, such a possibility is distant, but markets are already treating the latest monetary moves with scepticism.
Muddled thinking about deflation
Bernanke has a phobia about deflation, the book states. He ignores ‘good deflation’, for example computer and commodity price declines that ultimately lay the ground for economic revival. This is vastly different from ‘bad deflation’ that results from bank collapses and economic panic that cause a deflationary downward spiral of bankruptcies and rising queues of the jobless.
The book shows that during the lifetime of the Fed, this deflation generally arose because wrong-headed central bankers in the US, Europe and elsewhere ultimately caused asset bubbles that eventually burst. The latest market upheavals are a warning that the greatest risk from current Fed policies is another financial crash and recession rather than inflation.
Here are some examples Brown gives of Fed monetary blunders that became ‘an out of control monkey wrench’ that damaged the machinery in the US and global economy:
- 1915-1916 – The Fed plays a major role in prolonging the disastrous World War I by allowing US banks to finance the allied armies even though the Germans were trying to negotiate peace.
- During the 1920s, then-Fed governor Benjamin Strong pursued an easy-money policy and very low interest rates. The policies created a real estate boom and bust in Florida and eventually the Great Crash of 1929.
- In 1931, during the Great Depression, the Fed failed to steadily expand the monetary base to counter panic and ease pressure on banks. Later, during a recovery from March 1933 to 1937, the money stock grew by 50 per cent, interest rates were zero and equity and commodity markets boomed. A subsequent ‘monetary shock’ was followed by the inevitable collapse and recession. The economy recovered mainly because of armaments building ahead and during World War II.
- In the 1960s, then-Fed chairman William McChesney Martin and fashionable government Keynesian policies caused sharp fluctuations in the economy leading to the stock-market boom in the late 1960s and crash in 1970.
- In 1971, president Richard Nixon tore up the rule book by delinking the US dollar from gold. From that date serious dollar devaluation became the norm, buttressed by excessive money supply growth from Arthur Burns, the new Fed chairman. Partly due to the Organization of the Petroleum Exporting Countries, the oil price and other commodities soared while equities lurched up and down in bull and bear markets, as it has during the past 12 years.
- Paul Volcker took over in the late 1970s, first tightening money and causing a surge in interest rates, a soaring dollar and deep recession. In the mid-1980s, Volcker persuaded other countries that dollar devaluation was necessary. Volcker proved to be an arch-devaluationist.
- Alan Greenspan, appointed in 1987, also rejected monetary stability and, like Volcker, pushed the dollar down whenever it rallied. Ultimately, there was the tech stock-market bubble which peaked in 2000.
- By the early 2000s, Bernanke joined Greenspan and serious monetary irresponsibility and currency debasement began in earnest. This policy continued but by 2007, the Fed panicked. It was behind the curve during the market peak and kept rates too high for too long. That action precipitated the ultimate crash of 2008 to 2009.
Now we are waiting for the ultimate consequences of quantitative easing and the potential failure of the Fed to get its timing right and reduce the huge monetary overhang. Be ready to rush to the shelters.