Economic history is primed to repeat in the nastiest of ways unless the government stops distorting the price of something we use every day.
Every product, good, or service has a price, which is essential to rational decision-making. We use prices every day as vital data that guide us. Without true prices, prices not distorted by government fiat, we would make mistake after mistake. We would spend too much money on some things and too little on others. Borrowing other people’s money also has a price. It is called an interest rate. Central banks are often in the habit of distorting rates for the political benefit of governments, whose economic-nationalism policies have caused untold misery.
That is why so many critics of central banks have complained that, without a gold standard such as that suggested by economists Ludwig von Mises and Murray Rothbard, or without some tight controls on money creation — such as an automatic pilot advocated by Milton Friedman — it is inevitable that governments end up creating too much money. Monetary policies are ruled by politics. So money supply and interest rates come not from the interpersonal interaction of market forces, but from the whims of governments, which need to pay for everything, from entitlements to empires.
But cheap money, the same as any cheap input, leads one to overbuy and overproduce. Too much money is a frequent theme of economic history, whether in 18th-century France, with the banker John Law, or in the Continental Congress’s overissuance of its paper money in 18th-century America, the continental. That led disgusted holders of the devalued currency to use the expression that something was “not worth a continental.” It is why the advocates of limited government were generally suspicious of an American central bank. (Thomas Jefferson, an ardent anti-militarist, is reputed to have said that a central bank is a greater threat to liberty than a standing army.)
Overissuance of money backed by nothing but the promises of governments ultimately results in economies and markets that blow up. Such events have happened several times in my lifetime, and I believe they can happen again. That is despite the frequent assurances from the defenders of the central bank that it acts in an apolitical way, that its only goals are to promote healthy growth without excessive inflation.
That sounds impossible, tantamount to saying someone can gobble up cheesecake every night and never put on a pound. Yet the Federal Reserve, since the latest mess some five years ago, has provided the nation with a politically popular yet economically wrongheaded solution — it creates more and more money so the government is virtually giving away the currency. It is pushing a zero interest-rate policy.
Virtually zero percent interest rates are to long-term economic policy what junk food is to nutrition — it tastes great going down, but later come horrible results. Like a drug one can’t stop taking, artificially low interest rates initially seem harmless. Cheap money even seems to produce good results in the early stages. However, later comes disaster, which, once again, is looming.
Nixon and Greenspan
Let us consider the consequences of the policies of America’s central bank, the Federal Reserve, yesterday and today. The Fed often takes short-term actions that are politically popular — who doesn’t want to pay a low price for something, especially to borrow money? — but later tens of millions of people are hurt. When the economy is badly damaged, few seem to remember the cause of the woes. Richard Nixon is remembered for Watergate and the Vietnam War, not cheap money and wage and price controls, which caused problems throughout the 1970s. This is a point I will illustrate below. Given this historical illiteracy, the boom-bust cycle eventually starts all over. And then the only thing we learn from the history of central banks is that … most Americans never learn from history.
For instance, the Federal Reserve, just in time to reelect Richard Nixon in 1972, kept interest rates low, flooding the markets with cash. For a year or so the economy appeared better — just as today, when things seem somewhat better. However, it was a Potemkin-village economy. Stagflation followed a year or so later. There was close to a decade of misery, double-digit inflation, high unemployment, and an almost no-growth economy. It began when a new Fed chairman, Arthur Burns, was installed by Nixon with a charge of providing easy money. Money creation was 25 percent faster in 1972, than in 1971.
Later, after the easy-money policy inflicted pain on millions of Americans, Burns would title a speech “The Menace of Inflation.” The Nixon/Burns policies failed. Burns announced in 1974, “Inflationary forces are now rampant in every major industrial nation of the world.” (Central banks overseas, both then and today, generally followed the lead of the United States.) Burns conceded that “the gravity of our current inflationary problem can hardly be overestimated” (from his Reflections of an Economic Policy Maker).
Interest rates in the 1970s and early 1980s shot up to more than 20 percent. Interest-sensitive industries, such as cars and real estate, were devastated. Burns, by the way, blamed the woes on the huge deficits that the president and Congress, controlled by Democrats, were running. The parallels to today are stunning. Barack Obama and Congress have just set a record for red ink — four straight years of trillion-dollar deficits and uncounted off-budget red ink. These are deficits that lead some economists to claim that the United States is functionally bankrupt.
So are we about to go through another bout of stagflation or some other economic woe?
The stage seems set for it. For some time the Fed has been buying $85 billion worth of long-term government bonds each month to keep interest rates low. “In particular,” the Fed recently wrote, “the Committee decided to keep the target range for the federal funds at 0 to ¼ percent and currently anticipates that this exceptionally low range for the federal funds will be appropriate at least as long as the unemployment rate remains above 6½ percent.” That seemed to indicate that the zero option would continue for the foreseeable future.
Given that the jobless rate was 7.6 percent in June, that means unemployment would have to decline by about 15 percent to reach 6.5 percent. Yet the economy isn’t creating nearly enough jobs to reach that rate in the short term or maybe even in the long term. Perhaps the Fed understands that. In May it announced that it would begin curtailing the bond-buying program, but it was not clear when.
Once again, misguided, or politically biased, central-bank policies endorsed by the president and many in Congress have put the nation in a mess. It is a mess that could lead us back to the 2007/08 meltdown.
Today few would dispute that the Fed’s holding interest rates artificially low was a major component in the housing and market disasters of 2007/08. Anna Schwartz, a monetary historian, told the Wall Street Journal that “there never would have been a subprime mortgage crisis if the Fed had been alert. This is something Alan Greenspan has to answer for.”
(Anyone doubting Schwartz’s wisdom is directed to page 232 of Greenspan’s memoirs, where he reluctantly concedes that the Fed was responsible for the subprime failures of 2007, but, amazing to say, he continues to support the policy. “I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership distorts market outcomes,” he wrote. “But I believed then, as now, that the benefits of broadened home ownership are worth the risk.” The last part of that statement from Greenspan’s Age of Turbulence is shocking. It means that supporters of the central bank and its giveaway money deals are like the Bourbon kings — they “learned nothing and forgot nothing.”)
So cheap money, as it always does in its beginning stages, appears to produce recovery or even prosperity just as the economy is about to tank. What follows is a depression or maybe a recession or a slow-growth economy that seems more in recession than recovery. Whatever form it takes, it means misery for many.
Indeed, for millions of unemployed and underemployed Americans, many of whom voted for Obama believing he would provide prosperity, the recession continues in their lives. The consequences of easy-money policies, of the bizarre zero percent interest, are many and pose dangers for all of us.
First, how can central bankers know what is the right interest rate any more than Soviet central planners could know what was the correct price for bread or clothing or anything else? Contrary to economists such as John Kenneth Galbraith and Paul Samuelson who spoke positively about the Soviet economy right up to its demise, central planning can’t adequately feed or clothe nations or know how much money they need.
Indeed, central bankers playing with money markets are guessing, warns fund manager William Fleckenstein. “Like bureaucratic leaders of central-planned or command economies, they pick an interest rate to within two decimal places that they guess will be the correct one, and then proceed to cram it down the throat of the banking system,” writes Fleckenstein in Greenspan’s Bubbles.
Then, if the rate doesn’t reflect market forces, more problems follow. For instance, the United States has some of the lowest savings rates in the developed world.
The need for saving
Americans, for macro- and micro-economic reasons, desperately need to save more. They need to lower the true costs of capital by increasing the capital pool. And millions of Americans need to save for their children’s higher education. (Suggestion: Why not, in the interests of improving a weak economy, simply declare a saving and investment tax holiday? Then, when that improves saving and capital-gains levels, why not abolish those taxes forever? And, by the way, regarding the advocates of Keynesian policies who insist that government must continue to consume “to keep the boom going,” isn’t saving, as the Austrian economists tell us, just a form of delayed consumption? It’s a matter of what economists of the Austrian school call “time preference.”)
There are also tens of millions of Americans who need to save for a looming retirement because cuts in Social Security are likely in the name of “entitlement reform.”
The perils of rigging the bond and money markets and lowering their yields, as the Fed is doing, are many. For example, zero interest rates are difficult for retirees who depend on variable-rate annuities and bonds for part of their income. If retirees had known six years ago that the Fed would force and keep rates down, many would have invested their money differently.
But there is a bigger problem with zero interest rates, and it is one everyone should be concerned with, regardless of whether he is retired. The Fed once again could be creating a bubble, as it has several times before.
Many people are now turning to the stock market, not necessarily because they want to or because they like equities, but for another reason. It is one of the few investments in which they have a chance to get a decent return on capital. It is one of the few places where one has the chance of beating persistent implicit and explicit costs that drag down standards of living: the misunderstood tax — inflation — and the visible taxes we pay every day. But again, the cheap-money/stock-market option — what some commentators have called “the Greenspan Put,” an immediate Fed rate cut to pump up the market — is the biggest problem of zero interest rates. Here millions of investors are misled. They come to believe that cash is trash; that bonds are no good and that only stocks matter, which ultimately leads to a crash. It’s happened before.
For example, in the Burns/Nixon cheap-money episode discussed above, the stock market eventually crashed in 1973/74. The market, in an 18-month period, lost about 40 percent. Billions of dollars in value were destroyed. The consequences just for those near retirement were terrible. Imagine you had just retired with a lot of stocks in your retirement nest egg just before the crash of 1973/74. All of a sudden, your retirement plan wasn’t secure. You probably had to return to work or reduce your expected retirement lifestyle.
For about a decade, millions of Americans wouldn’t touch stocks. The damage was felt for a long time. “For years, I didn’t want to come to work,” I remember an old-time stockbroker telling me. By the end of the decade, the average investor was so disgusted with the stock market that Business Week famously ran a cover story entitled “The Death of Equities.”
If the Fed doesn’t stop rigging the capital markets it could be the death of millions of portfolios, the death of the savings and investment plans of millions of Americans who have depended on a currency that has been abused for the benefit of governments, both Republican and Democrat.
“So let me warn you again,” writes business columnist John Crudele in the April 16 New York Post, that “the only thing this market has going for it is the Federal Reserve’s persistent money printing operation.” He warns that if an investor can’t afford to lose 20 percent in a hurry, he should get out, as easy-money policies will, as they did in the 2007/08 super storm, destroy trillions of dollars of assets.
Central bankers will blunder again and again. That is, unless most Americans, many of whom who would resist the fixing of their wages, call for an end to these vicious money cycles of the central bank, with its tampering with interest rates. They must realize a simple economic truth: The government’s fooling with the price of money is a prescription for disaster.
The logic is indisputable. The warnings of Jeffersonians and other central-bank critics over centuries of monetary history should be heeded. The central bank should be abolished.
This article was originally published in the August 2013 edition of Future of Freedom.