2009 – The Year
Monetarism Enters Bankruptcy
By
Henry C.K. Liu
The invasive dominance
of monetarism in macroeconomics has been
total ever since central bankers, led by Alan Greenspan, who from
1987 to 2006 was Chairman of the Board of Governors of the US Federal
Reserve, the head of the
global central banking snake by virtue of
dollar hegemony, embraced
the counterfactual conclusion of Milton Friedman
that monetarist measures by
the central bank can perpetuate the boom phase the business cycle
indefinitely, banishing the bust phase from
finance capitalism altogether. Going beyond Friedman, Greenspan
asserted that a good central bank could perform monetary miracle by
simply adding liquidity to maintain a booming financial market by
easing quantitatively at the slightest hint of market correction,
ignoring the fundamental law of finance that if
liquidity is exploited to manipulate excess debt as phantom equity on
a global scale, liquidity can act as a flammable agent to turn a
simple localized credit crunch into a systemic fire storm.
Ben Bernanke,
Greenspan’s successor at the Fed since February 1, 2006, also
believes that a “good” central banker can
make all the difference in banishing depressions forever, arguing on
record in 2000 that, as Friedman claimed, the 1929 stock market crash
could have been avoided if the Fed had not dropped the monetary ball.
That belief had been a doctrinal prerequisite for any candidate up
for consideration for the post of top central banker by President
George W. Bush. Yet all the
Greenspan era proved was that mainstream monetary economists have
been reading the same books and buying the same counterfactual
conclusion. [See
also Fekete's 'Forbidden
Research' notion.] Friedman’s
“Only money matters” turned out to be a very dangerous
slogan.
Both Greenspan and Bernanke had been seduced
by the convenience of easy money and fell into an addiction to it by
forgetting that, even according to Friedman, the role of central
banking is to maintain the
value of money to insure steady,
sustainable economic growth, to moderate cycles of boom and bust by
avoiding destructively big swings in money supply. Friedman
called for a steady increase of the money
supply at an annual rate of 3% to achieve a non-accelerating
inflation rate of unemployment (NAIRU) as a solution to stagflation
when inflation itself causes high unemployment. Stagflation
is a de facto invalidation of the Phillips Curve which
shows a negative correlation between the rate of unemployment and the
rate of inflation. There is of course irrefutable logic within the
workings of a capitalistic labor market in support of the
concept of structural unemployment. Yet the
conceptual flaw in NAIRU is its acceptance of a natural rate of
unemployment as a justification to abandon the socioeconomic goal of
full employment. When unemployment of 6% of willing workers is
accepted as structural in an economic system, the
fault is with the system, just as if a
hospital accepts an annual mortality rate of 6% of its curable
patients as structural, the hospital’s operation needs to be
reexamined. The fundamental
flaw in market capitalism is its inherent failure to deliver full
employment as a social goal.
Monetary easing should only be tolerated in
times of real systemic financial distress [nope
– not even then! -FNC] in the
economy. It should never be administered as a convenient anesthetic
to forestall market corrections. Instead,
[Easy Al] Greenspan
in his 18 years at the Fed had repeatedly treated every cyclical
market downturn as a potential systemic crisis that justified massive
liquidity injection by the central bank, only to create larger and
larger serial price bubbles as new phantom
cycles of growth to defy financial
gravity.
Yet while the laws of
finance can sometimes be violated with delayed penalty, they cannot
be permanently overturned. The fact remains that central banks cannot
repeatedly use easy money to fund serial economic bubbles without
cumulative consequence. Undetectable debt can be disguised by
structured finance as phantom
equity, but it remains as liabilities at
the end of the day. Risk can be spread globally system-wide but it
cannot be eliminated. The
result will be a global financial meltdown when this massive Ponzi
scheme on the part of central banks
is finally exposed.
Greenspan, by his cavalier application of massive liquidity to
sustain phantom serial monetary booms, has driven the
narrow validity of monetarism into policy
bankruptcy. Bernanke, by his blind faith in the power of misguided
monetarist measures to deal with a global credit crisis created by
decades of runaway monetary
indulgence, has unwittingly neutralized
even the antibiotic power of Keynesian fiscal countermeasures against
demand deficiency in a monetary bust from excessive debt. Deficit
financing in a recession does not work without a reservoir of fiscal
surplus from a previous boom.
The Fed under Greenspan
and Bernanke had violated
the basic rules of both monetarism (money supply management) and
Keynesianism (demand management). Fed
monetary policy created false prosperity with excess money supply to
fund debt manipulation and simultaneously to support income disparity
as a source for capital formation to exacerbate overcapacity amid
demand weakness.
The Greenspan Fed repeatedly provided
easy money in massive scale
to fund serial asset price bubbles that were passed off
as economic growth. And deregulated finance globalization endorsed
enthusiastically by Greenspan led to wide income disparity in the
entire global economy. Thus income
in every economy eventually failed to support rising asset prices
pushed up by debt to unsustainable levels.
This forced the excess phantom capital in the global economy to seek
growth from manipulation of debt collateralized by a price bubble
that was destined to collapse from inadequate cash flow. [whew!]
Structured finance allows general risk in all debts to be
unbundled into tranches in a hierarchy of credit rating, allowing
even the most conservative to participate in the debt bubble by
holding the supposing safe low-risk tranches. But
the safety of these low-risk tranches is merely derived from an
expected low default rate of the riskier tranches. As
default rate of the high-risk tranches rises, the safety of the
supposedly low-risk tranches vanishes. With
runaway “supply-side” voodoo economics keeping wage
income in check during the boom phase in corporate profits, the
resultant overcapacity from demand lag resulting from low wages shuts
off investment opportunities for productive expansion and forces the
excess money supply into speculative manipulation of debt, giving
birth to restructured
finance and sophisticated, circular
hedging of risk.
A decade
of excess money had produced a credit overcapacity which was solved
by a systemic under-pricing
of risk and a lowering of credit standards
for so-called sub-prime borrowers. While sub-prime mortgage was at
first mostly a housing sector problem, the derivative effects of
sub-prime failure quickly infested the entire global financial
system. These interconnected factors that fueled the spectacular
process of serial bubble formation at unprecedented rate and on
unprecedented scale to support the
false claim of neoliberal finance capitalism as the most effective
and efficient economic system in history turned
out to be the same factors that brought the entire global capitalist
financial system built on debt crashing down in July
2007.
Since [KBE
since Sept 2002] Greenspan left the Fed in
2006, a year before the global crash, when mainstream analysts were
still praising him as a god-sent savior of debt-propelled finance
capitalism, it was left to Bernanke to continue the Greenspan magic
to keep the good times rolling perpetually. Not unexpectedly, when
the liquidity-fed debt
tsunami hit the financial sector in July
2007, Bernanke confidently assumed that the
Greenspan Put [“The
Fed's pattern of providing ample liquidity resulted in the investor
perception of put protection on asset prices. ”]
would again save the financial system from another
collapse of the latest of Greenspan’s serial bubbles.
When pressed by Congresswoman Rosa DeLauro (D-Conn.) during a
hearing whether the economy was in a recession, Bernanke dismissed
the question with the professorial hubris reserved for a college
freshman that “recession” is only a technical description
of economic conditions. “Whether it’s called a recession
or not is of no consequence,” declared the former Princeton
professor. Still, as there was even at the time general consensus
that market confidence had emerged as a major issue, whether a
slowdown is classified officially as a recession has serious
consequences in market attitude. Bernanke’s arrogant brush-off
to a perfectly valid commonsense question from a concerned legislator
presumed to be unwashed in economics theory showed how disconnected
the elitist high priest central banker was to earthy reality.
Bernanke was complacently confident he could stop the
wave of massive financial destruction caused by decades of abuse of
liquidity excess by again
adding more liquidity through massive
creation of new money. The Fed under Bernanke, instead of saving the
economy from the cancer of debt, actually continues to be part
of the problem by feeding
the spreading debt cancer.
(Please see my October 23, 2008 AToL article: US
Government Throws Oil on Fire)
Eight years earlier, Bernanke had declared his faith in
aggressive monetarism when he wrote in the September/October 2000
Issue of Foreign Policy an
article entitled: A Crash Course for Central
Bankers:
“A collapse in US stock prices certainly would cause a lot of white knuckles on Wall Street. But what effect would it have on the broader US economy? If Wall Street crashes, does Main Street follow? Not necessarily. Consider three famous episodes: the U.S. stock market crash of 1929, Japan’s crash of 1990-1991, and the US crash of 1987.
The 1929 U.S. crash and the sharp decline in Japanese stock prices were both followed by decade-long economic slumps in each country. (The Japanese depression, despite much whistling in the dark by the country’s policymakers, still lingers.) By contrast, the macroeconomic fallout from the 1987 tumble on Wall Street was minimal. Why the difference?
A closer look reveals that the economic repercussions of a stock market crash depend less on the severity of the crash itself than on the response of economic policymakers, particularly central bankers. After the 1929 crash, the Federal Reserve mistakenly focused its policies on preserving the gold value of the dollar rather than on stabilizing the domestic economy. By raising interest rates to protect the dollar, policymakers contributed to soaring unemployment and severe price deflation. The US central bank only compounded its mistake by failing to counter the collapse of the country’s banking system in the early 1930s; bank failures both intensified the monetary squeeze (since bank deposits were liquidated) and sparked a credit crunch that hurt consumers and small firms in particular. Without these policy blunders by the Federal Reserve, there is little reason to believe that the 1929 crash would have been followed by more than a moderate dip in US economic activity.
The downturn following the collapse of Japan’s so-called bubble economy of the 1980s was not as severe as the Great Depression. However, in some crucial aspects, Japan in the 1990s was a slow-motion replay of the U.S. experience 60 years earlier. After effectively precipitating the crash in stock and real estate prices through sharp increases in interest rates (in much the same way that the Fed triggered the crash of 1929), the Bank of Japan seemed in no hurry to ease monetary policy and did not cut rates significantly until 1994. As a result, prices in Japan have fallen about 1% annually since 1992.
And much like US officials during the 1930s, Japanese policymakers were unconscionably slow in tackling the severe banking crisis that impaired the economy’s ability to function normally.
Central bankers got it right in the United States in 1987 when they avoided deflationary pressures as well as serious trouble in the banking system. In the days immediately following the October 19th crash, Federal Reserve Chairman Alan Greenspan—in office a mere two months—focused his efforts on maintaining financial stability. For instance, he persuaded banks to extend credit to struggling brokerage houses, thus ensuring that the stock exchanges and futures markets would continue operating normally. (US banks, which unlike their Japanese counterparts do not own stock, were never in any serious danger from the crash.) Subsequently, the Fed’s attention shifted from financial to macroeconomic stability, with the central bank cutting interest rates to offset any deflationary effects of declining stock prices. Reassured by policymakers’ determination to protect the economy, the markets calmed and economic growth resumed with barely a blip.
There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the US economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.”
In his 2000 article of
faith, Bernanke was openly endorsing the
“Greenspan Put”, the monetary stance from late
1980s on during which whenever the economy slowed, the Fed would come
to its rescue by radically lowering the Fed funds rate target even to
the point of negative real yields as measured against inflation, and
kept it there until a new boom bubble was solidly formed. The
Greenspan Put repeatedly pumped liquidity into the market to avert
the price correction consequences of speculative excesses that caused
the 1987 crash, then the geo-economic consequences of the First Gulf
War in 1991, then the contagion effects from the Mexican Peso Crisis
of 1994, then the Asian Financial Crisis of 1997 and the Russian
default that caused the collapse of LTCM in 1998, then the phantom
Y2K digital threat, then the bursting of the Internet dot.com bubble
in 2000 and then the market panic from the 2001- 9/11 terrorist
attacks to launch the sub-prime housing bubble that burst in July
2007.
Accordingly, Bernanke was complacently confident
that another application of the Greenspan Put can again handle the
burst of the housing bubble in July 2007. He appeared to have no
inkling that the economy had been drawn closer each time since
1978 into a perfect storm of structured finance run amok.
On May 17, 2007, three months before the credit crisis broke out,
Bernanke said in a speech on The Subprime Mortgage Market at
the Federal Reserve Bank of Chicago’s 43rd Annual Conference on
Bank Structure and Competition:
“… given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable.”
The top US central banker did not see what Greenspan later called “the crisis of a century” coming at him at full speed to hit him in the face in four weeks. Even on August 31, 2007, six weeks after the credit crisis broke out in mid July, Bernake still spoke with surprising calm confidence in a speech on Housing, Housing Finance, and Monetary Policy, delivered at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium at Jackson Hole, Wyoming:
“Importantly, the easing of some traditional institutional and regulatory frictions seems to have reduced the sensitivity of residential construction to monetary policy, so that housing is no longer so central to monetary transmission as it was. In particular, in the absence of Reg Q ceilings on deposit rates and with a much-reduced role for deposits as a source of housing finance, the availability of mortgage credit today is generally less dependent on conditions in short-term money markets, where the central bank operates most directly.
Most estimates suggest that, because of the reduced sensitivity of housing to short-term interest rates, the response of the economy to a given change in the federal funds rate is modestly smaller and more balanced across sectors than in the past. These results are embodied in the Federal Reserve’s large econometric model of the economy, which implies that only about 14% of the overall response of output to monetary policy is now attributable to movements in residential investment, in contrast to the model’s estimate of 25% or so under what I have called the New Deal system.
The econometric findings seem consistent with the reduced synchronization of the housing cycle and the business cycle during the present decade. In all but one recession during the period from 1960 to 1999, declines in residential investment accounted for at least 40% of the decline in overall real GDP, and the sole exception--the 1970 recession--was preceded by a substantial decline in housing activity before the official start of the downturn.
In contrast, residential investment boosted overall real GDP growth during the 2001 recession. More recently, the sharp slowdown in housing has been accompanied, at least thus far, by relatively good performance in other sectors. That said, the current episode demonstrates that pronounced housing cycles are not a thing of the past.
My discussion so far has focused primarily on the role of variations in housing finance and residential construction in monetary transmission. But, of course, housing may have indirect effects on economic activity, most notably by influencing consumer spending. With regard to household consumption, perhaps the most significant effect of recent developments in mortgage finance is that home equity, which was once a highly illiquid asset, has become instead quite liquid, the result of the development of home equity lines of credit and the relatively low cost of cash-out refinancing.
Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time. This smoothing in turn should reduce the dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate. These inferences are supported by some empirical evidence.”
Bernanke was
still twiddling his theoretical thumb in the comfort of his
institutional bunker while the whole financial world was falling
under a credit fire storm. With the
awesome data collection capability at his disposal, the Fed
Chairman’s radar apparently
totally missed the possibility of systemic
collapse of the non-bank
credit market on structured finance from chain-reaction effects of
rising subprime mortgage default. As the housing bubble burst, home
equity loans collateralized by inflated home prices were putting most
home mortgages under water and an increasingly large number of home
equity borrowers in default. The sudden reversal of the wealth effect
was about to destroy the global economy, albeit with a time lag, as
Bernanke gave his reassuring speech based on faulty
economic theory.
Before
the credit crisis developed in July 2007, institutional clients of
global money center banks had a range of non-bank options to access
funds. Such options included the $1.2 trillion short-term commercial
paper market collateralized by solid asset price and cash flow
prospects. Interest rates for commercial paper were normally lower
than bank credit rates. Borrowers used banks credit mostly as a
temporary backup in the unlikely event that a rollover of maturing
commercial paper debt faced unforeseen temporary difficulties.
The credit market went into shock when the
commercial paper market abruptly and effectively seized and stayed
frozen to all borrowers in mid July. Banks
suddenly had to rely solely on inter-bank funding to provide promised
credit to clients at a time when cash
supply was expected to be squeezed by the usual year-end liquidity
shortage. Banks all over the world whose costs of borrowing are based
on the London Interbank Offer Rate (LIBOR) market found LIBOR jumping
to 202 basis points (2.02 percentage points) above US Treasuries in
the third quarter of 2007.
Only after the commercial
paper seizure hit the LIBOR did the Federal Reserve belatedly realize
that the credit market was not clearing efficiently. Half
of the world’s outstanding finance
of $150 trillion which includes financing for derivative trades is
routinely tied to LIBOR rates. The risk of
global recession from widespread toxic infection of the entire credit
market caused by rising defaults of US subprime loans was creating
panic in the market. The Fed and the Treasury, official guardians of
a stable financial market, were the
last parties to know that a systemic
crisis was about to implode and had only hours to act from their
offices in New York when government officials were told
by major US financial institutions management that they would be
unable to meet their global obligations when markets opened in Asia.
Again, an injection of liquidity
to forestall an imminent financial crisis was administered by the
Fed, notwithstanding that the crisis was in essence an insolvency
problem of too much debt with insufficient revenue. Illiquidity
was merely the
outcome, not the cause. Corporate profit,
as measured by the Commerce Department, fell $19.3 billion in the
third quarter 2007, as domestic earnings dropped to $41.2 billion.
Yet the drag from sagging US sales and huge financial write-downs
from credit losses were offset by still robust earnings abroad,
amplified by a weakening US dollar. Operating profits for S&P 500
companies fell 2.5% in the third quarter, the first drop in more than
five bubble years. Much of the damage was initially concentrated in
the financial sector, where operating earnings fell 25%, as banks and
brokerage houses suffered losses from subprime mortgages holdings and
related investments.
The credit crisis that imploded
in July 2007 was not a Black Swan event that could not be predicted.
It actually began in late 2006 when inevitable
residential subprime defaults that had
been warned by a few lonely voices on the Internet from a few sober
analysts years earlier were
finally being reported in the general
print media and popular TV programs on finance. The general consensus
continued to claim the
economy to be fundamentally sound. Pundits
at the Wall Street Journal, CNBC and Bloomberg told the clueless
public to take advantage of buying opportunities as the market headed
south.
By the end of the first quarter of 2007,
speculative institutional buyers of investment properties at
overblown prices began having problem accessing easy credit to close
their overpriced deals. Nervous investors in high-yield fixed income
debt began redirecting their funds towards risk-free Treasury notes
and bills, driving prices up and interest
rates down. Balance sheet loans (cash
generated from operations) from banks and insurance companies were
still available but at far more conservative credit terms and higher
rates. Still, mainstream analysts were insisting the sky was not
falling.
The pace of securitization, including
commercial mortgage-backed securities (CMBS) issuances, slowed
moderately during 2006 and 2007 from the fast pace set between 2002
and 2005, especially for high-leverage private sector issuers. The
trend was hailed as a successful soft landing by mainstream pundits
while in reality any slight
loss of upward price momentum is lethal for a debt bubble.
The stock and bond markets reacted to the rising rate
of delinquencies among subprime residential borrowers as the housing
bubble deflated. Investors lost confidence in even the top-rated
tranches of the securitized subprime loans and all
asset-backed securities became illiquid.
Hedge funds managed by Lehman, Bear Stearns, Merrill Lynch, Goldman
Sachs and others that had purchased subprime asset-backed securities
(ABS) reported huge losses as [and
if] their portfolios were marked to
market. Globally, off shore hedge funds and major banks in Germany
and France that invested in subprime ABS also reported significant
losses. Investors seeking to increase returns had leveraged
their ABS holdings which, when applied to a market
decline, exponentially drove prices even lower.
Large
US investment banks had pooled subprime residential asset-back
securities (ABS) totaling $383 billion and sold the paper to
investors worldwide in 2006. By September 2007, 21% or about $80
billion of the mortgage securities were in default, plus another $20
billion sold by smaller firms. There were $18 trillion of all forms
of outstanding ABS, and market analysts estimated at the time that
marked-to-market losses would be in the range of $400 to $600
billion. Yet media
reports cited only about $150 billion of acknowledged losses as of
the end of 2007. The trough, of which no one had any reliable
estimate, remained in the unknown future despite the Federal
Reserve’s frantic rate reductions, which by December 2008 has
reached near zero.
The impact of the subprime defaults
had been magnified as firms
purchased for a fee slices of these original-rated pools and
repackaged the assets a second time, rated them a second time, and
later sold them as lower-tiered units at
higher yields to investor with bigger risk appetite. The impact has
been global as most international money center banks have offices in
all major financial centers around the world. (Please see my November
27-29, 2007 AToL three-part series on Pathology
of Debt)
Going forward, the credit crisis will
bring down the retail and
office real estate sectors in all
economies as a global re-pricing of risk alters the viability of
maturing medium-term loans coming due in coming years. From early
mid-2004 to mid-2007 real estate developers, lenders
and property owners used a menu of complex
financial instruments to gain access to low-cost funds and shift risk
off their balance sheets to the investing public. Easy access to
credit had driven capitalization rates way down and debt-financed
deal volumes up to new record levels every year since 2002.
Institutional-grade assets had been priced using exponents in future
cash flow assumptions in an upward-bending positive parabolic curve.
It is inescapable that when global credit markets turn sour, the
effect is an equally downward-bending negative
parabolic curve.
To be
fair, Bernanke was in good
company among establishment experts of
equally unjustified complacency. Brookings Policy Brief Series #164
dated October 2007,
three months after the credit crisis imploded, used as headline:
Credit Crisis: The
Sky is not Falling. The
brief by Anthony Downs, who describes himself on his website as the
“World’s Leading Authority” on real estate and
urban affairs, asserts that
“… the facts hardly indicate a credit crisis. As of mid-2007, data show that prices of existing homes are not collapsing. Despite large declines in new home production and existing home sales, home prices are only slightly falling overall but are still rising in many markets. Default rates are rising on subprime mortgages, but these mortgages—which offer loans to borrowers with poor credit at higher interest rates—form a relatively small part of all mortgage originations. About 87 percent of residential mortgages are not subprime loans, according to the Mortgage Bankers Association’s delinquency studies. Subprime delinquency rates will most likely rise more in 2008 as mortgages are reset to higher levels as interest-only periods end or adjustable rates are driven upward. Unless the U.S. economy dips dramatically, however, the vast majority of subprime mortgages will be paid. And, because there is no basic shortage of money, investors still have a tremendous amount of financial capital they must put to work somewhere.”
However, while
this complacent view was
widely held in the financial
establishment, not everybody was drinking the Cool-Aid. Instead of
“tremendous amount of financial capital”, the entire
financial sector was seriously undercapitalized as distressed debts
added up losses. Warnings had been publicly aired months before the
credit crisis imploded in July 2007 by a few lonely voices of more
sober analysts that the subprime mortgage bubble would burst and its
effect would spread globally, granted that such warnings had been
summarily dismissed by the establishment media. (See my March 17,
2007 AToL article:
Why
the Sub-prime Mortgage Bust Will Spread)
By
December 2008, eighteen months after the credit crisis broke out in
July 2007, events have conclusively proved that Bernanke’s
faith in the magic of the Greenspan Put had been misplaced. Decades
of misapplication of Friedmanesque monetarism [and
anyway, who wants
a monetary system that can
survive, apparently healthy, under decades of mismanagement? For that
matter, who wants a monetary system that has to be (or even can
be) managed at all (in any
but the most straightforward way)? Straightforward, like providing
minting of assured quality and prosecuting counterfeiters.] had
driven the doctrine into theoretical bankruptcy. Monetarist measures
not only fails to revive an economy caught in a global debt tsunami,
there is also clear evidence that the liquidity cure devised by
Greenspan has eventually run out of ammunition as the serial bubbles
get bigger each time to paper over the previous one. The Greenspan
Put does not work for a stalled economy facing a liquidity trap of
absolute preference for cash. It only adds more water to a raging
flood of debt to threaten even the shrinking remaining high ground.
The flaw in his faith in self-regulating monetarism
that Greenspan openly confessed before Congress apparently did not
get through to Bernanke who continues
to apply the Greenspan Put. Bernanke’s
futile monetary moves to save
wayward financial institutions only
managed to increase the immunity of the deeply wounded economy
against any Keynesian fiscal cure by the next occupant of the White
House and his economic team. Bernanke made the same mistake of
obstinate denial
in the early phases of the economic meltdown from a debt
crisis even after his acceptance eight years earlier of Friedman’s
counterfactual conclusion that the Fed in 1930 failed to act in time
to effectively respond to the oncoming disaster with bold monetary
countermeasures. Again, the world missed another opportunity to test
if preemptive Keynesian fiscal cures will work.
More
fundamentally, rather than a timely monetary cure as proposed by
Friedman in hindsight, Hoover should have applied Keynesian demand
management through fiscal spending to maintain full employment
immediately after the 1929 crash, if not before. No recovery from
speculative excess can be expected without a policy-induce rise in
employment and wage income to catch up with an asset price bubble. It
was true in 1929; and it is true today.
Unfortunately,
the rescue approach by the Bush administration led by Treasury
Secretary Henry Paulson and the Bernanke Fed has been focused
on saving distressed financial institutions by providing taxpayer
money to restructuring bad debts and
de-leveraging overblown balance sheets. This approach inevitably
pushes already stagnant wage income further down with more layoffs
and ruthless renegotiation of already draconian labor contracts to
cut operating cost. All this does is to reinforce the downward market
spiral by transferring financial pain to innocent workers while not
helping the economy with needed revival of consumer demand.
Trillions of good taxpayer money are being thrown
after bad debts concocted by unprincipled financiers
into a crisis black hole. This money would have to be
repaid in coming years by tax payers while Supply-siders are
clamoring for tax cuts for corporations, on capital gain and for high
income earners. This means the future tax bill to pay for the
Greenspan put will be borne by low and middle income wage earners.
Thus far in this financial crisis, the Bernanke Fed has not sowed the
seeds for a quick recovery but for a
decade or more of stagflation for the US
and the global economy.
January 1, 2009
Next:
Central Banking Practices Monetarism at the
Expense of the Economy