Politics
A Response
by Patrick Cooper
Earlier, Clay Staggs put up a blog posting from the Belmont Club. I would like to take the time to unpack some of the things mentioned. First and foremost, credit is, for better or worse, the blood of the economy. Everyone uses credit every single day. If you don’t believe me, look at your electricity bill. You do not pay ahead of time; instead, after checking your CREDIT, the utility extends you CREDIT so that you don’t have to either pre-pay for the month or make a payment at the end of every day. Because of this, utilities go into the CREDIT market and borrow money. They may issue commercial paper, bonds, or may sell the accounts receivable at a discount in order to obtain funds. What would happen if your utility could not get credit? It would go out of business and you wouldn’t have electricity. This is why TARP was necessary. TARP is the Troubled Asset Relief Program. I may disagree with how the Administration used the funds, but overall, it was necessary. So what caused this credit crisis? It is true that interest rates were probably too low, which allowed individuals and firms to borrow excessively, which in turn led to a higher-than-average default rate that occurred all at once. We know what caused the higher-than-average default rate (excessive lending) but what caused it to happen all at once. James Hamilton, a prominent economist at the University of California-San Diego, argues that the high gas prices of last summer caused defaults to increase suddenly. You can read the paper here. In my humble opinion, TARP and the purchase of assets by the Federal Reserve was necessary and sufficient. We’ll collectively call these the Bailout. If only the Bailout was used, the economy would have recovered. However, it wouldn’t have recovered soon enough for the likes of politicians. So we got the Stimulus, which includes the projects and government ownership of car companies. This was not necessary, and definitely not sufficient. Finally, let’s talk about the Federal Reserve. We hear all these stories about the Fed being controlled by banks, the Bilderbergers, the Hamburglar, etc. All policy of the Federal Reserve is set by the Federal Open Market Committee (FOMC). Who comprises the FOMC? It is made up of 12 individuals, 7 of whom are from the the Board of Governors, which oversees the entire Federal Reserve System, which includes the 12 regional banks. Each of the 7 is confirmed by the Senate. The other 5 are Federal Reserve Bank presidents, one of whom is always the President of the Federal Reserve Bank of NY; the other four rotate on a yearly basis. While it is true that banks make up a large part of the board of each bank, it is those who have been confirmed by the Senate that make up a majority. So even if the Hamburglar wanted to bring about the end of the United States via the Bank of International Settlement in Switzerland, which is the new alleged puppetmaster of the Fed, it can’t be done. Independence of the Fed is necessary to ensure that it does not do unnecessary things.
Posted by Patrick Cooper at May 31, 2009 03:18 PM
Patrick,
Do you believe that an attempt will be made by Congress to undo that independence so that Congress can inflate its way out of the debt?
If not, why not?
Clay, it would set a dangerous precedent. Currently, there is a bill in the House (HR 1207) that is sponsored by Ron Paul that allow the government to audit the Fed’s books. This is simply a backdoor way to limit the independence of the Fed. With Fannie Mae and Freddie Mac having been bailed out by the Government, China, I believe is more worried about rampant inflation than it is about a straight up default. And the reason is this: inflation is a judgement-proof way to reduce one’s debts. So, theoretically, the government could borrow all it needs and then let inflation take its course and in real terms the debt is nothing. I do not believe that Congress will remove the independence of the Fed simply because once that happens, China will not lend us money; it will simply start purchasing hard assets. However, what I do worry about is the replacement of Fed governors as their terms expire (or they opt for a more lucrative career) with inflation doves. Bernanke is an inflation hawk and many believe he will not be given another term as Chairman when his term expires in 2010. And this worries me because I think that inflation will ramp up in 2011. Since monetary policy has a lag effect of between 6 and 18 months, the actions of 2010 will greatly influence what happens in 2011.
I just have a few comments on the article by Leo Linbeck III and the Hamburgler’s response. And, as far as the prediction goes, there is no telling what a looney Congress will try to do, and I would be much more comfortable with the Hamburgler (or the Grimace for that matter) running Monetary Policy in either case.
1) Leo notes that he believes the Fed stepped into the long bond market to keep ARMs low. Could be. Just my opinion, but I believe the Fed has stepped into the long bond market because it had too. The last auctions have not sold out, thus forcing the Fed to step in. Would you buy a long bond from someone with 50 to $100T of unfunded liabilities? Whether the markets have realized it or not, this is evidence that default is already starting to occur. As Patrick notes above, printing money to pay a bond is essentially default on the debt. It should be no surprise if the near future bond auctions (in now staggering quantities) do not have enough buyers either.
2) In his note on “Fiscal Policy” Leo states that the governement redistributes wealth either by taxing or printing money. In principle this is correct, but it is a great misconception to say the “government” prints money. It is actually the commercial banks backed by the Fed that create new money. When you take out a loan for a house/car/etc, this is newly “printed” or “created” money that the bank (or banking system if you prefer) has created. It is not “honest” money sitting in the vault that the bank has “rightfully earned” that is just waiting to be lent.
3) Leo predicts a “showdown” between Congress and the Fed over control of the Fed and this may very well be. This is a topic for another day, but I believe it does not really matter. Both the Fed and Congress are tied at the hip of mutual interest even if they are independent of each other. Again, this will have to be argued fully another day but consider the following:
The Fed’s self interest (or banks self interest which the Fed facilitates) is to allow the banks to print money and thus greatly expand their profits.
Congress self interest is to allow politicians to spend money without restraint. How does the Fed facilitate the banks printing money? Via fractional reserve banking which allows banks to print money while holding a small reserve requirement of actual assets. What are the assets a bank can use as a base on which to expand the money supply via lending? Gold, cash, and bonds. Gold is currently a non-factor, not likely that the Fed will voluntarily revalue gold (another huge topic for another day). Cash cannot be expanded once the money multiplier effect has run its course. Bonds - bingo! The banking system as a whole requires injections of new bonds as an asset on which to expand its balance sheet. This can only happen if Congress runs continuous debts, which is exactly what Congress wants to do. Again, we can fully argue this point another day.
4) At the end of his arguement Leo comments that if Congress gets control of the Fed it is game over. Maybe so, this is certainly not a good thing. However, I think game over is when the Treasury holds a bond auction and there are not enough takers. At this point the Fed must step in to prevent bond market collapse. However, the Fed stepping in is evidence of currency collapse. The only question is how long it takes for all players to recognize this as a currency collapse. The last one to recognize the Matrix will be holding a big bag of game over.
Regarding the short term credit markets: It may be a current wide spread practice for utilities and other businesses to enter the short term credit markets to finance operations, but it is certainly not necessary. For any normal business, this is a matter of cash flow. You produce your product (i.e. pay for labor and materials first) and then you sell it, this requires either startup capital or positive cash flow. Electric utilities, apartments, etc, usually require a deposit prior to issuing service. This is another way around the credit market.