The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing...
Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem...
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
But then I read this piece, by Robert Shiller (hat tip Yves Smith), and all of a sudden I'm frightened. It's one thing when Hank Paulson proposes turning the Fed into the macroeconomy's philosopher king. Paulson will be gone in a blink of an eye. But Robert Shiller is an increasingly influential economist. He's already got Mark Thoma signed up for the plan. These guys are smart, they matter, and they will continue to matter next January. So let's think about this very, very carefully.
Shiller points out that...
In recent years, central banks have not always managed macro confidence magnificently. The Fed failed to identify the twin bubbles of the last decade — in the stock market and in real estate — and we have to hope that the Fed and its global counterparts will do better in the future. Central banks are the only active practitioners of the art of stabilizing macro confidence, and they are all we have to rely on.
He's right on both counts. For now, central banks are all we have to prevent a catastrophic unwinding of our unstable financial system. But they had everything to do with getting us here. It's not just the Fed, with its famous "serial bubble-blowing", its cheering on of any novelty as beneficial innovation, its absolute refusal to peer into the magical sausage factory that Wall Street had become. The problem with central banks is much bigger than that. If you haven't been obsessing over every word Brad Setser has written for the past several years, you owe yourself an education. A growing "official sector" has largely defined the global macroeconomy in the first years of this millenium. In the USA, Japan, China, Europe, central banks have indeed been "active practitioners of the art of stabilizing macro confidence". For most of those years, it seemed like they were succeeding. They were never succeeding. Call it what you want, call it "Bretton Woods II", call it "financial imbalance" or a "global savings glut" or "exorbitant privilege". Each central bank, while trying to stabilize its own bit of the world, found itself with little choice but to support and expand unsustainable financial flows on a scale so massive they have reshaped the composition of every major economy on the planet. As Herb Stein told us, what cannot go on forever won't. "When the music stops, in terms of liquidity, things will be complicated." Remember that? The music may have stopped already for Citibank, but it's still playing for the USA. The record is just beginning to skip.
The Federal Reserve can keep every major US bank and investment house on life support for as long as it wants to. The "credit crunch" can be made to disappear in an instant, if we are willing to pay sufficient ransom to hostage-takers. But what the US economy produces is no longer well matched to what Americans consume, and we are structurally unprepared to generate tradables, goods or services, in quantity adequate to cover the difference. The Fed's magic wand will be of no use if manufacturers in Asia and oil producers in the Gulf stop giving us stuff for free, using central-bank financial alchemy to hide their generosity.
Things may turn out okay. We've already begun to "adjust", and knock on wood, we'll manage a worldwide reequilibriation before things get too ugly. But it'll be a close call. That financial alchemy by central banks is the ultimate source of skyrocketing inflation in China and the Gulf states, and an ominous sign that Stein's Law is beginning to bite. We may yet escape, but we have been drawn very close to something very dangerous, to a genuine crisis of scarcity in the United States and a catastrophic failure of Say's Law in China, to mass unemployment, social instability, and fingers and missiles pointed in both directions across the Pacific. This is serious stuff. And central banks are largely to blame.
Private, profit-seeking actors would not have generated the corrosive financial flows that have characterized this millennium. "Financial imbalance", a euphemism for real resource misallocation, would have quickly been corrected, had Wall Street and the City of London not learned that the official sector could be their best customer. Less politically-independent monetary authorities could have leaned against unsustainable financing. A bit of capital-account protectionism might not have been bad policy for the United States during this period, but a central bank blind to obvious "facts on the ground", accountable only to an economic orthodoxy, did not even consider such a thing.
As readers of this blog know, I'm not a laissez-faire, the-private-sector-is-always-right kind of guy. I like to think about the "information architecture of the financial system". That leads me to dislike actors large enough to unilaterally move markets, especially when their motives might not be aligned with wise resource allocation. I dislike large private banks, and think they should be broken into itty-bitty pieces or turned into safe, regulated utilities. For the same reason, I dislike central banks. They have the power to act consequentially, but they do not have, and cannot have, the information or the wisdom to always be right. And when they are wrong, the consequences are devastating.
So, what to do? For now, we have no choice but to "use the army we have". Our long-term plan, though, ought not be to canonize central banks, but to render them obsolete. It won't be easy. The usual "sound money" trope, reviving the gold standard, is not a good idea. Much as it is suddenly out of fashion, we will need some "financial innovation" to build a new monetary architecture. Just because we've had a glut of snake-oil on the market recently doesn't mean there's no such thing as penicillin. We'll have to do a better job of distinguishing novel idiocies from good ideas. But we will need the good ideas. We can and should liberate money from the bankers, central and otherwise.
- 6-Apr-2008, 9:45 p.m. EDT: Replaced "manager" with "manage", 'cuz I wanted a verb there.
|Steve Randy Waldman — Sunday April 6, 2008 at 4:00pm||permalink|