The three Federal Reserve presidents of the Federal Reserve Banks of Boston, Chicago and San Francisco want the Federal Open Market Committee (FOMC) to start a new round of security purchases by the Federal Reserve. Eric S. Rosengren in an interview with CNBC called for
He said it should have no stated limit:
He said that the FED should buy more mortgage securities:
His is a program of unlimited inflation. His is a program of overpricing long-term securities. His is a program of a bloated central bank. His is a program that inflates the housing sector and starves other sectors.
The results of Rosengren's recommendations are bubble prices in asset markets, low returns to savers, increased uncertainty, low investment in capital goods, and stagnant economic activity. The result is economic activity too heavily focused on housing and not enough on technical and industrial growth. The result is a movement away from investment in securities and into assets that hold their value against the inroads of inflation. The result is a slower recovery. The result is to hinder price changes and movements of people to new lines of work. His is a program that thwarts a healthy, natural and broad-based economic recovery from the recent real estate and financial intermediary fiasco.
John C. Williams has nearly the same position as Rosengren, as shown in a recent interview summarized in the San Francisco Chronicle. Charles L. Evans of the Chicago Fed also wants the FED to start buying more securities again, until consumer prices start rising by 3 percent a year and unemployment falls to 7 percent. These are numbers. Manipulating the economic activities of 300 million Americans to achieve numbers is like trying to get into heaven via sorcery.
These admirers of inflation hold to the wrong economic model. The FED never should have bought its current portfolio of mortgage securities in the first place. It should sell these securities now. For the FED to start a new round of security purchases is a terrible, terrible idea.
These three men are Keynesians and/or new Keynesians. The difference between an old and a new Keynesian is their models. This is a technical difference, not a matter of substance. The latter use models that explicitly incorporate such features as maximizing behavior, sticky prices, expectations, and new methods of estimation. What's far more important than these technical bells and whistles is that Keynesians of all stripes share common assumptions and views. All of the following bullet points that they believe in should be rejected:
There is no reason even to list these lunatic beliefs and behaviors except that the lunatics are running the asylum. Take the opposite of each bullet point to get nearer to truth. Bear in mind that economics can state truths and some of these can be stated mathematically, but yet economics is not an exact science in the sense of routinely coming up with algebraic constants or numbers that explain the economic activities of many millions of people. People are not like molecules in a gas whose activities can be explained by Boyle's Law. There are not economic constants like the gravitational constant.or Planck's constant. Most economists pretend to the exactness of physics by ignoring and oversimplifying reality to the point of misunderstanding economic behavior.
Let's get some context on the trio's proposal that the FED start a new round of mortgage bond purchases by looking at the history of the FED with respect to mortgage-related securities (MRS). The FED on November 25, 2008 announced that it would buy $600 billion of such securities:
This was a huge innovation. The FED, which began in 1913, had never ever bought any MRS before. The amount it would buy was immense compared to its usual credit. On November 21, 2007, prior to any of its several credit-extending measures, its total credit was $868.136 billion. This step alone meant a 69 percent jump in its balance sheet. This was unheard of.
If it's so unusual, why did the FED do this? The FOMC tells us in that quote that it was "to reduce the cost and increase the availability of credit for the purchase of houses." It was for the housing market. Why was that called for? Was the cost of mortgage credit too high? NOT AT ALL. The government had had its hands on the housing market since the 1930s. The government had seen to it that housing got overbuilt. It had made the credit flow extremely easily. Americans had just been through an orgy of home buying on very easy terms. The FED had its hands on credit markets since 1913. It had helped make credit easy for decades. Here are the undeniable facts. The 30-year conventional mortgage rate was 7.3 percent in early 1971. Before that, people were used to 5-6 percent. The 70s had so much inflation (due to the government and the central bank) that the mortgage rate went up to a peak of 18.45 percent in October of 1981. Then it fell, and it fell for decades. In early 2008, it was back under six percent. When the FED made its first announcement bemoaning the cost of mortgage credit in November of 2008, the rate was 6.09 percent.
The FOMC's housing justification was misleading. The bolstering of financial markets was one of their real reasons, because in the aftermath of some major failures of financial companies in September of 2008, the stock market had dropped severely. This "bolstering" is, however, sorcery. The FED cannot make stock prices rise in real terms. The FED's ability to manufacture high-powered money (electronic digits) can cause prices to rise, but it cannot produce more goods. The real value of a stock depends on its real cash flows, and they depend on real profits based on the hiring of real factors of production and sales of real goods. Real values do not depend on cash flows expressed in inflated prices. More FED-printed money doesn't make Amazon or any other company a more productive company. It may cause one company to produce more, but it will be at the expense of some other companies producing less. The aggregate economy cannot be made more productive by printing money. More production of goods that people want takes land, labor and capital goods in combinations that produce the desired goods. This is the work of a free market economy, not a central bank or a government. Keynesians not only fail to acknowledge this truth, they deny it.
As evidence, note that in the year following the FED's announcement, the stock market (the S&P 500) rose by 33.4 percent, but gold rose by 44.2 percent. Gold is a real asset that is sensitive to the inflation in fiat money that the FED possesses as one of its major tools. In the following two years after the FED's announcement (through Nov. 25, 2011), gold rose 65.9 percent and stocks rose 46.2 percent. After three years, stocks were up 44.3 percent and gold up 102 percent. And through the current date, gold is up 93.8 percent compared to a stock market rise of 79.2 percent.
In real gold terms, the stock market has not advanced in almost 4 years, despite the FED's enormous money printing. It has not kept up with gold. It will catch up and outperform gold under two conditions. The first is that the FED does not start inflating again. The second is that the government does not produce negative shocks to the economy. Without FED and government negatives, natural economic recoveries occur.
The FED's other reason for QE1 was to bail out the government-sponsored housing agencies: Fannie Mae and Freddie Mac. It was to bail out the institutional investors in the MRS securities, rather than let them realize their losses. It was to prop up the prices of MBS, rather than let investors take their losses. It was to keep the existing institutional structure intact as far as possible.
The FED did a joint venture. It joined the central bank to the housing agencies, which are already merged with the government. It did fiscal policy through its power to buy securities. It did this without the necessity of Congressional debate and approval, and Congress didn't object. The FED also made itself the main customer of financial intermediaries who originate and hold the securities that the FED has purchased and may purchase in the future. The FED integrated backwards to the government and forwards to the financial markets. The FED spread.
Although some members of the FED have no qualms about exercising its power in this way, it radically transforms the central bank into an arm of the government that supports a targeted sector (the housing sector) by subsidizing its cost of finance. If the FED targeted the defense sector or the drug sector or the agricultural sector for such preferential financing, the inherently fascist and inflationary nature of what it is doing would be more evident. But since the government has been monkeying around with housing for so long, there has been no widespread or general opposition to the FED's expansion. There has hardly even been recognition of its nature or of the huge power that has lain dormant in the FED's charter and now has come out into the open (excepting various critics among whom Ron Paul and his followers are prominent).
Let's look at the size of the FED's interventions.
The first $600 billion buying program that we've been discussing is part of what is commonly called QE1. That program also included $300 billion of U.S. Treasury securities. QE1 later was expanded. On March 18, 2009, the FED added $850 billion to the buying of MRS:
In sum, the FED said it would buy $900 billion of U.S. Treasury securities and $1.45 trillion of MRS. The latter included $1.25 trillion of MBS and $200 billion of GSE or agency debt.
At the present time, the FED has $946.373 billion of MRS. The FED has reduced its holdings from their peak levels. The peak in MBS was $1,128.661 billion on June 23, 2010. The FED sold off or let run off (through maturation) enough securities to reduce this to a local low of $827.052 billion on November 30, 2011. The MBS account is currently $856.997 billion. The GSE hit a high of $169.011 billion on March 10, 2010 and has since been reduced by the FED to $89.376 billion.
A footnote to the FED's balance sheet says of the MBS "Guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Current face value of the securities, which is the remaining principal balance of the underlying mortgages." The FED accounts for these securities at face value, not market value. What's of prime importance here is the link between the FED and these government agencies, which in turn are linked to the mortgage markets and the housing markets.
Fannie Mae and Freddie Mac went bankrupt. The federal government placed them into a "conservatorship". They have not been liquidated. They are still operating. The federal government has the legal authority to advance funds to these entities, limited only by the ceiling on the national debt. The FED accomplished the other part of the bailout by keeping the MBS market going.
The FED's purchases of MBS accounted for 32 percent of the total amount of MBS outstanding at the end of 2009: "In short order, the Federal Reserve became the dominant player in the secondary mortgage market."
At the present time the mortgage rate is 3.55 percent. In view of this, what is now going through the minds of the Keynesians at the FED? As the conventional thinking goes, they want to "stimulate the economy". How? By lowering yields still further. Their position is incredible. They would totally distort the housing market and the economy in order to get to a number (7 percent unemployment rate). This is like getting a patient to have a temperature of 98.6 by injecting some drug while ignoring its destruction of the patient's organs.
One of the effects of the FED's buying was to raise MBS prices and force yields lower. Several research papers estimate that during the FED's buying, mortgage rates fell by 0.3 percent to 1 percent due to its buying. Mortgage rates fell after the FED stopped its buying and if that drop is attributed to the FED, and not to a soft housing market, then the estimate becomes 1 to 1.5 percent.
The FED's balance sheet expansion has had two focal points: the U.S. government itself (U.S. Treasury securities) and Fannie and Freddie (the MRS). Now we have three FED presidents who want more buying of the MRS (and perhaps Treasuries too). This time around the reason is not to bail out the housing agencies and keep them going, although any such buying will have that effect. They justify their proposals under the mandate from Congress to seek full employment consistent with price stability. They would expand the buying based, of course, on their belief that the result of the FED's buying will be full employment and price stability (the fourth tenet listed above).
Yikes! More accommodative? How accommodative can you get? Go ahead, buy every security in sight until their yields are zero. Only you'll never get there. Long before zero happens, people will be taking the electronic digits you are paying them with and converting them into real assets. Don't these inflationists realize that expectations can suddenly change, like a dam bursting? This is not in their models. They are the sorcerer's apprentices. If they go too far in expanding the FED's balance sheet, people are going to stop believing that they will ever exit. They will begin to expect endless inflation. The dam will break and a severe inflation will occur.
And whom are they "accommodating" anyway and why? Beware of sorcerers who use cant and ritual. When they intone magic words like "accommodation", "overcome frictions", "instability", and 'stimulate spending", they are repeating the rituals they learned in their colleges and universities. It is not as if there is a shortage of money. Our Keynesian central bankers think that America is not at full employment because people cannot get loans at reasonable rates. Yet the banks are loaded with reserves. Corporations are highly liquid. Interest rates are low. The reasons for unemployment must be sought other than in a lack of funds to lend. For an Austrian economics primer on unemployment, see here.
Our inflationist trio is not thinking in terms of financial distress as did the FOMC in 2008. They are thinking that the FED can and should bring about full employment by bringing down mortgage interest rates.
The FED can bring about full employment. It can buy MBS extensively, reduce the yield drastically, and induce people to borrow money to build and buy homes. Since the government guarantees these securities, any losses will be shifted to the government and taxpayers. Alternatively, by cutting the rate it pays on reserves, it can induce banks to lend money to currently sub-marginal borrowers. As they spend, employment will rise for awhile. The FED can create an inflationary bubble economy. It has done this before. The government can also bring about full employment. It can start public works programs. It can borrow money from the FED and spend it, again creating an inflationary bubble economy.
The sorcerers on the FOMC can heat up the cauldron and create a brew. But should these bubble economies be created by central authorities? Should America in the 21st century be subjected to 20th century policies of central control that in various forms failed after being put into practice by fascist and communist dictatorships? Bubble economies crash. The employment they create is unsustainable. People waste time and resources in production that other people do not want. A bubble in housing means that too many houses are being built and not enough of other goods that people want. A bubble in consumption means that people are not saving enough to finance capital goods. Economic growth then slows down. A bubble induces speculation in land and stocks. Their overpricing leads to wealth redistributions and resource mis-allocations.
America and other countries are now experiencing the consequences of a severe housing bubble. Does it make sense to reinflate a housing bubble or inflate other new bubbles as this trio of incompetent Keynesian economists recommends?
If and when the FED draws people and resources into the production of houses by subsidizing the cost of capital in the housing sector, they will be drawing people and resources away from other sectors and industries. Why should the FED have the say on what gets produced and what doesn't? Obviously, there is no place for such a privilege in a free society.
Did the people make the FED its economic czar? Never. People are just beginning to learn what it is.
How can the FED possibly know what goods should be produced so as to enhance the general welfare? It cannot. Economists know this, but ignore it. A favorite phrase of economists who write articles is "We will ignore..."
The FED is looking only at unemployment rates. Unemployment is not the general welfare, not by a long shot.
How can the economy ever adjust if the FED is interfering with credit and manipulating it in certain directions and not others? It can't. How can it adjust if the FED manipulates the overall cost of credit? It can't. What we have now with FED-directed monetary policy is a continual manipulation of the economy because each such a manipulation is the excuse for a subsequent intervention. This roller coaster is not at all distasteful to the FED or the government. They batten on it.
It would take a separate article for me fully to convey to the reader the actual degree of ignorance among economists, including those on the FED and FED presidents. Just think of mediums or sorcerers with a distorted understanding of the spiritual and you will be close. But I will give you the flavor of what I have in mind.
To the layman their articles seem sophisticated due to their mathematics and specialized vocabulary and techniques. But the fact is that most all models are tentative tries at understanding. As an example, the FED is supposedly trying to enhance welfare by its policy measures. The FED has objectives. They are full employment and stability of consumer good prices. In meeting these, it is supposedly making people better off. But a major review article in a top economics journal titled "The Science of Monetary Policy: A New Keynesian Perspective" co-authored by Mark Gertler, who has been a close associate of Ben Bernanke for 30 years, says in 1999 that economists don't know how to give good reasons for the FED's policies:
It adds that "there have been a number of attempts to be completely coherent in formulating the policy problem by taking as the welfare criterion the utility of a representative agent within the model." In other words, economists have tried to rationalize policy measures by assuming that one person (a representative agent) stood in for everyone in the economy.
These are mathematical-minded economists admitting in veiled language that they cannot devise a model that supports the idea that the FED's policies enhance the general welfare. They then become more explicit:
The words highly misleading give away the game. Modelers have tried a single-agent approach to justify monetary policy, but it doesn't work. Why not? Well, obviously there are actually very large numbers of distinctive persons and groups whose welfare varies with many factors that no one-agent model can capture. Does this deter the model-builders? Heck, no, they simply assume a mathematically tractable objective function:
Then the cleverest among them finds some rationale for making that simplifying assumption. Furthermore, the FED itself and its economists are just as much in the dark as these economists who are trying to rationalize monetary policy:
In another part of the same article, we are told
That's an open admission that the FED does not know what it is doing.
Here is an example of that word "ignore":
Centrally-controlled money has all the defects of any centrally-controlled (socialistic or fascistic) sector of an economy. The controllers disturb equilibrating market processes. They distort incentives. They cannot gather dispersed information and ever do justice to the decisions of individual companies. They cannot fathom the considerations that go into an individual's welfare-enhancing decisions. There is no way for a central bank committee to mimic the latter with some aggregate quadratic or other loss function. They are bound to use limited models of an economy. Most often, the models will simply be wrong. They will always be inadequate. These statements and others appear via the Austrian (or any sensible) economic analysis. They are confirmed by the 100-year record of the FED in action.
Some deluded people have the idea that 12 FED sorcerers (the number on the FOMC) know enough to be able to turn the money faucets on and off at the right times so as to make the economy work. They have never known enough before and they will never know. That's because an economy is not like a flow of water that's controlled by turning faucets on and off. Every model the FED has ever had, from its simplest old Keynesian model up to its most detailed new Keynesian models, has grave defects.
Now, for those who do not accept these conclusions and who think that the 12 Keynesian sorcerers on the FOMC are the answer to whatever is causing repeated banking crises, it needs to be said openly, loudly and clearly. No, absolutely not. These twelve people, whatever their virtues, are, in the face of a complex economy, stupid and ignorant people. So are we all. What do I mean? I mean that no matter how good they (or any of us) are in mathematics, model-building, and getting the computer to solve log-linear equations numerically; no matter how many degrees they have, no matter what their IQs are, and no matter how many journal articles they have published; no matter how much they try to maximize some objective function that supposedly mimics the general welfare, they will fail miserably. I would too if I sat on the board.
The FOMC should be dissolved. It should be replaced by free markets. They work. Mistaken Marxist sorcery on labor, profit, capital, and markets needs to be buried and buried deeply.
Up to this point, I have written as if the FED had a legal warrant for inflicting monetary policy on the populace. Now I switch trains. I attack the FED on constitutional grounds.
It's clear that the powers of the FOMC are enormous. The FOMC members are in a privileged position. Should the members of the FOMC have these powers? Absolutely not. Even for those who accept the U.S. government and the U.S. constitution, the Federal Reserve (FED) is unconstitutional (see chapter XII of The U.S. Constitution and Money). There are basically seven reasons why the FED is unconstitutional:
So, anyone who accepts the legitimacy of the U.S. government and the constitution has solid legal grounds for concluding that the FED and its money are both unconstitutional. These grounds alone are enough to support ending the FED.
Central bankers are modern day sorcerers using powerpoint slides. They garb themselves in academic respectability. They garb themselves in mathematical models and econometric estimations. They produce learned papers written in guarded academic language that they abandon when they use the power to print money. Powerpoint slides do not necessarily commune with truth. What powers do these sorcerers actually possess? The central bankers can print money and give credit to banks. They can distort economic activity. They can cause bubbles. They can burst bubbles, leading to recessions and depressions. But the FED cannot create real value. The FED is a lunatic sorcerer. It boils up cauldrons and splashes them into markets. It waves fiat wands and believes that its liquids are producing oil wells and refrigerators. The economists who endorse the black art of central banking and believe in its power are legion as are the media figures who interview them and pollute the airwaves with their sorcery. That's all it is. Sorcery. Keynesian sorcery. Lunatic sorcery.
August 20, 2012
Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire: Liberty vs. Domination and the free e-book The U.S. Constitution and Money: Corruption and Decline.
Copyright © 2012 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit is given.