Thursday, January 10, 2008

Taking a Look at All That's Broken

David Wessel has a great piece today in today's Wall Street Journal, enumerating the ways "the business model for big U.S. banks is broken."

broken
[Thanks to photographer Alana and travelblog.org for the photo.]

He lists three: (1) The ever-ingenious ways lenders have found to distance themselves from risk; (2) the fragility of the financing world's computer modeling technology; and (3) the disintegration of the reliability of the rating agencies. His solutions are a mix of more evolved regulation and self-correction.

I add to his mix that maybe the banking model is not the only thing broken and contributing to our present woes. What about the world's fiat monetary system?

Bernanke today gave a speech about future Fed intentions, reassuring the markets that they will lower the interest rate when and as necessary. At the same time, he is frank about the Board's inability to predict a recession.

He tells a great story about his own experience at the NBER (National Bureau of Economic Research), the entity that actually has the authority to declare recessions official. He tells us the truth: In sum, that economic statistics are an after-the-fact science.

This is a major admission on his part, and I applaud his openness. In sum, he has (correctly) declared economics to be an immature science, and that trying to predict the future is pointless--which pretty much eliminates the Fed's raison d'etre.

Greg Ip, the author of a WSJ article today on this subject, points out that Bernanke's position at NBER upon his departure went to a couple of economists, Christina and David Romer, who have just come out with negative press about the Bernanke Fed's proposal to publish the Fed's economic forecast more often--which intention, by the way, is another laudable effort by the Fed to be more transparent.

The Romers claim, according to Brian Blackstone at the WSJ, that such forecasts are of little use because, among other reasons, the Fed makes forecast decisions that do not conform to its own staff's data.

Ip points out that even the Romers' theory itself is challenged by other researchers, i.e. that even their criticism is not supported by all the evidence.

My conclusion here again? Economics does not support the Fed's raison d'etre. In fact, it barely supports it's own.

In another Ip article giving an excerpt from Bernanke's speech, we read that Bernanke says that "'any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate' its job in the future."

This reminds us that the Fed's actions depend not just on flaky statistics, but also upon the Fed Governors' interpretation of something as vague as public "expectations." How fuzzy-wuzzy is that as a statistical indicator?

I don't feel guilty about bringing to the attention of my readers that the Fed model is also broken, even if in doing so I'm contributing to those dangerous "expectations" and to Fed credibility "erosion." It just takes an honest, well-meaning fellow like Bernanke to admit it, that's all. The Fed's credibility is flawed because its modus operandi is flawed--indeed, has been since 1913, the Fed's birth day; and it's high time we all admitted it and came to grips with it.

We need to get through this mess as best we can, and then let the market take over from the Fed and invent a new way to stabilize interest rates, employment and prices.

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