Monday, August 27, 2007

Who Is At Fault? The Central Banks

Will Hutton, in this article from the Observer of London, appearing at the Gold Anti-Trust Action Committee website, is on a rampage. And I sympathize with his emotions, if not entirely with his recommendations.


"While obeisant governments bail out dodgy plutocrats, it's ordinary people who foot the bill."

"One of the most inequitable and amoral acts in modern times is happening in front of our eyes...."

"The multi-billion dollar bailout of global finance after one of the most reckless periods of lending and deal-making since the late 1920s is extraordinarily one-sided. Little people's taxes are underwriting the mistakes of big people, who in the process have made riches beyond the dreams of avarice. Globalisation, it is now clear, is run in the interests of a global financial class which has Western governments in its thrall. This class does not give a fig for the interests of savers, clients or wider workforces. The rules of the game are set up solely to benefit the financiers whether in London, New York, or Hong Kong."

"Interpol should make arrests in New York, London, Tokyo, Beijing, Frankfurt, and Paris, starting with all the executives in the credit-rating agencies who blithely ranked the debt as creditworthy in exchange for fat fees and freebies from the very banks who were making the absurd loans. Governments should bring suits against the executives involved, the repositories of vast personal wealth, to help repair the hole in private and public balance sheets."

" It is as though Europe and America had announced an amnesty to the world's criminal gangs after they had gone on a killing spree because they feared the killing would get worse."

* * * * *

These are harsh words, and one can't help but identify with his ire. But I believe his call for hanging the culprits is a little over the top, because like Robespierre, he's got the wrong defendants.

Greenspan tatoo
[Thanks to Robolove3000 for this great tatoo.]

Everyone is forgetting the most important element in all of this: The identity of those who allowed all of this to happen. Why does everyone forget that it is Greenspan's Federal Reserve Board that decided to lower the target interest rate from 6.50% to 1.75%, i.e. almost five whole percent, in the space of one year from January 1, 2001 to January 1, 2002? And who continued to lower that rate to 1.00% up to July of 2003? Who is it who didn't start to retract until July 1 of 2004, slowly lifting rates back up to 5.25% in July of 2006?

Housing was already taking off worldwide, but the US Fed chose to ignore it, even publishing papers to the effect that the housing boom was not a monetary phenomenon. (See my previous post and my cartoon on the subject. I wrote an economic analysis of one ridiculous paper, but no one cared to publish it.)

I thoroughly admire the Fed's latest efforts at transparency and their desire to act in a predictable fashion from 2004 to 2006, raising the rates only by .25% at each announcement; but what I deplore is the Fed's conviction that they can produce anything positive by their manipulations, fast or slow.

The Fed is useful in times of panic as a kind of overseeing clearinghouse, i.e. when it can influence the day-to-day machinery of banking operations and issue temporary emergency credit to avoid useless trauma to the system. However beyond that, the Fed is helpless--indeed harmful--when, in addressing its government-appointed mission, it attempts to influence the business cycle, employment, prices, and the general economy.

Why are their attempts so futile? There are several well-known but forgotten reasons.

1. Their methodology is in direct conflict with their mission. They act upon statistics, and statistics by nature are a molasses-in-winter, after-the-fact phenomenon, whereas their idea of management of the economy requires preemptive measures.

2. Their powers of intervention are in direct conflict with the mission of all market players. As Hayek said in The Road to Serfdom, "If the individuals are to be able to use their knowledge effectively in making plans, they must be able to predict actions of the state which may affect their plans." This implies that any arbitrary or unpredictable actions on the part of the Fed throw a wrench into the plans of those whose goal is to succeed within the "invisible hand" marketplace. If everyone has one eye on the profit line and the other on the Fed, obviously they are focusing only half of their attention where it should be; and they must include in their plans sufficient reserves to cover the unpredictability of the Fed's actions. Surely this is an expensive and unnecessary handicap.

3. The Fed's interference in the marketplace creates a whole new profession: That of outguessing the Fed. Every bank and financial institution in the world, and even some whole companies, are devoted to analyzing global markets as they gyrate around central bank intervention.

4. Fed interference creates imbalances in business cycles that encourage otherwise useful market players to become reckless and spendthrift. Hedge funds, credit derivatives, and those bank departments that trade in them have created the problems we are experiencing today, based on the latest ballooning of credit made available by the world's central bankers in 2001. Thus the Fed, with the collaboration of these risk-players, is directly responsible for the euphoria of today's boom/bust situation.

5. Fed interference creates moral hazard. It is reliance upon the Fed's capacity to bail out financial crises--powers well over and above their clearinghouse duties--that encourages risk-takers to assume too much risk at the expense of the taxpayers.

* * * * *

Why has everyone forgotten these self-evident characteristics of centralized monetary control? [Sigh]

So if we're looking for someone to hang, let's look at ourselves. We are the ones responsible for centralizing our government and allowing legislators to create and empower a Federal Reserve in the first place. Let the taxpayers pay for this one; but let them also rise up in anger against the central banks to prevent another such credit cycle.

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