Saturday, August 26, 2006

The Guy Who Would Be King (at the Fed)

Professor R. Glenn Hubbard, Dean of Columbia Graduate School of Business, was a runner-up in the race to become Federal Reserve Chairman. He was also chairman of President Bush's Council of Economic Advisers from 2001 to 2003.

Glenn Hubbard

He expresses opinions close to my own about the Fed's responsibility for our present situation. In a Reuter's article, he is quoted at the recent Jackson Hole Kansas City Fed's retreat as saying:

"I do believe policy had been too accommodative for too long. And now the question is, How do we deal with the current situation?"

Then Reuter's paraphrases him thus:

"The U.S. central bank, under Bernanke's leadership since February, 'still has enormous credibility with the public,' which is helping to keep inflation expectations contained, Hubbard said."

I would agree that the Fed still has enormous credibility with the public, and even within the business community. After all, they believe (and so does the Fed itself) that the Fed has the power to control the money supply and influence the American economy.

But whether or not it is this credibility that is keeping inflation expectations contained, I am less sure. Business will increase prices when push comes to shove, and it hasn't yet because (in my humble opinion) prices are being kept in check by shrinking consumer purchasing power.

Here's how this wide-reaching vicious circle works. The arresting of prices (and wages, by the way) is caused by limitation of consumer spending capacity, which in America is dependent on two things: (1) their creditworthiness, some of which is evaluated on their real wealth as measured in real estate holdings -- which measurement has stabilized and most likely will soon be reduced; and (2) investors' diminishing willingness to furnish the money behind the credit. (We've reached the end of the CDO, MBS, etc., market expansion potential.)

It's called stagflation, folks. It's here. And it's all the Fed's fault. They created this credit bubble in the first place, and now they can't get us out of it. As I've said before, the Fed is between a rock and a hard place. If they increase rates in September, they'll throw turmoil into the housing market and the economy will start to demonstrate recession-like symptoms. If they decrease rates, they'll make a stock market bubble and eventually plunge the long-term dollar into the toilet. If they do nothing, one of two things could happen: (1) we'll let ourselves be strung us along for the stagflation ride, which could go on for some time; and/or (2) at some point the various market players involved may decide they've had enough, and we get some hot action -- if they can afford to, which some of them can't (Japan, China, et al.) Option 2 could therefore mean fireworks, or more stagflation.

Is the Fed making things better or worse by carrying on the charade of control? That is the question. I know they were just trying to avoid a deeper recession in 2001, but if you ask me (which you haven't), I think that someday in the relatively near future, the market will force the Fed out of the money supply/credit business.

I think's it's already happening. Gold is already waiting outside the back door, can't you hear it knocking?

PS: If you haven't seen the parody by some of Columbia Business School's students of Hubbard's "disappointment" at not receiving the Big Chair at the Fed, you've gotta see this:

Hubbard Parody


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