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What is Bernanke Doing?

Posted by on Tuesday, January 22, 2008 11:38:30 AM
The other day I complained about Federal Reserve Chairman Ben Bernanke's testimony before the House Budget Committee because he lent his support to a fiscal stimulus package. I was also angry because Chairman Bernanke indicated that the Fed would lower interest rates further, which many in the market figured mean by 50 basis points. That's what I was expecting and dreading, but nope. In an emergency meeting of the Federal Open Market Committee this morning, the Fed cut the federal funds rate by 75 basis points.

A lot of talking heads seem to be happy about this, and I'm not quite sure why. CNBC's Lawrence Kudlow was clamoring for something similar last night:

"Fed head Ben Bernanke should have cut rates 50 basis points last week. He should do it first thing this morning. Then cut rates another 50 basis points on January 30.

"Importantly, central banks must work together and cut rates together. They must coordinate to avoid major financial consequences. They must show investors, financiers and business people that they are in charge.

"In this deflationary environment, plunging commodities, stocks and credit risk-free government bond yields are all signaling central bankers to take charge. That means lower rates and more money creation."

Really? Deflationary environment? Clearly Mr. Kudlow pays someone else to do his grocery shopping for him, because my grocery bill's going through the roof. He must be driving a hybrid these days, too, because I'm pretty sure gas isn't the cheapest thing anymore, either. Yes, I know the Fed strips out food and energy prices when it looks at inflation because they're volatile, but somehow that academic reason isn't very comforting. Before stripping out food and energy prices, inflation was 4.1 percent for 2007. Even after stripping out food and energy prices, inflation was still 2.4 percent. Housing prices may be falling relative to other prices, and they need to, but that doesn't seem to be happening elsewhere. Given large price increases in energy and health care and the ridiculously low value of the dollar--which unrealistically low interest rates are responsible for--deflation is a long, long way off.

According to Mr. Kudlow, all the world's central bankers need to cut rates in tandem to avoid global inbalances. If central bankers in the European Union, Japan and elsewhere didn't cut rates in lockstep, then the value of the dollar would plummet. Believe it or not, the opposite happened just before the Great Depression. The Fed left American interest rates high to help prop up the British pound, but when we couldn't sustain it anymore because of our own domestic inflation, we abandoned the scheme and the British pound collapsed. If Mr. Kudlow would have us put our faith in the rest of the world, then he's teaching us to be betrayed.

The reason Mr. Kudlow is giving such bad advice is because of a huge conflict of interest. He wants stock prices to go up, the consequences be damned. In theory, when the Fed cuts interest rates, the stock market jumps because government bonds yield a smaller return relative to stocks. People try to get into stocks and the stock market goes up to establish a new equilibrium. Didn't happen this morning, did it, Mr. Kudlow?

Dr. Milton Friedman is spinning in his grave at a rate that would make the velocity of money jealous. Loose monetary policy is no substitute for having our own fiscal house in order. The Fed should not try to micromanage the economy or moderate the business cycle because it is horrible at it. Instead, Chairman Bernanke needs to get his act together and stop indulging Wall Street whiners like Mr. Kudlow. If the Fed keeps inflation at bay and protects the value of the dollar, then Wall Street and Mr. Kudlow will actually be better off in the long run. If Congress is worried about the underlying, long-term health of the economy, then all it has to do is cut spending and cut taxes. Reducing the size of the government relative to the economy will prevent it from crowding out investment and lead to more stable long-term interest rates and higher economic growth, since private businesses and individuals will spend their money in far more efficient and productive ways than the government ever could.
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Bernanke's Blunder

Posted by on Thursday, January 17, 2008 12:24:12 PM
I have a lot of respect for Federal Reserve Chairman Ben Bernanke, and I think he's probably the most qualified person to run America's central bank. That's why I was disappointed when he lent his support to the idea of an economic stimulus package when he testified before the House Budget Committee this morning. Chairman Bernanke testified that tax rebate checks, probably between $300 and $600 per family, would help to stimulate spending so long as the government issued them quickly. He also testified that the Fed would take further action as needed. The resulting speculation that the Fed would cut the federal funds rate even further from 4.25 percent to 3.75 percent has me even madder than this economic stimulus.

Using interest rates to game the markets and moderate the business cycle is exactly what got us into this mess in the first place. Lowering rates below what they should reasonably have been allowed the housing market to superheat. Houses were incredibly overpriced but people kept buying so long as interest rates were low. The Fed had to raise rates eventually, however, because a superheated economy eventually creates inflation, and inflation can destroy an economy. When rates went up, people stopped buying houses and banks foreclosed on some mortgages, so prices plummeted to offset the huge excess supply. This correction is inevitable and the more we try to delay it, the more we draw out the pain.

Lowering the federal funds rate from 4.25 percent to 3.75 percent, as many economists and analysts on Wall Street seem to think the Fed will do, will only add to the dollar's problems. The European Central Bank's key interest rate currently stands at 4.00 percent, and as our rates decline relative to theirs, the dollar will only slide in value relative to the euro. That may help prop up American manufacturers and exporters in the short term, but in the long term it weakens them because it's an artificial insulation from competition. In the meantime, foreigners will continue gobbling up American assets and inflation will rise. A new report out yesterday shows that inflation in 2007 hit its highest point in 17 years. We're teetering on the brink of a level of inflation that we haven't experienced in my short lifetime, and I'd just as soon avoid it.

This economic stimulus is just as foolish, although probably not as dangerous. As Robert J. Samuelson explains in Newsweek:

"Folks, we have a $14 trillion economy. A one-time stimulus (rebates aren't permanent tax cuts, and grants to states would probably be temporary) of $75 billion or $100 billion is too small to do much. If the economy is in serious trouble, something much larger is needed. But if the outlook is not so dire, then a modest stimulus plan is mostly political symbolism."

Actually, I think we need something larger anyway, but something entirely different. This country has a long-term problem that no short-term band-aid will fix, and that's our large deficits and the overall size of our government relative to our GDP. At the end of the third quarter of 2007, data from the Bureau of Economic Analysis showed that the government accounted for nearly 20 percent of GDP. That's too much. The government needs to spend less money so it doesn't need to collect as much money and businesses and individuals can spend more of the money they earn. A stimulus package is foolish because it puts into people's hands money that doesn't really exist. If the government were to reduce spending and pass the savings on to businesses and individuals, then that would really do something. Instead, it's just adding the cost of this stimulus to its tab.

Chairman Bernanke probably realizes what refusing to intervene in the economy would do to the markets in the short term. If he were to refuse to cut interest rates and say publicly, abruptly and out of the blue that the Federal Reserve would no longer try to micromanage the business cycle, then there probably would be a panic because the markets have come to expect the Fed to indulge them. They are addicted to it. Chairman Bernanke is trying to avoid precisely that kind of panic, and that is wise. Nevertheless, Chairman Bernanke needs to say publicly and forcefully, albeit gradually and over time, that the only things that will strengthen the American economy over the long term are balanced and shrinking budgets that decrease the tax burden on businesses and individuals. Government needs to shrink relative to GDP, and as it does, the economy will become stronger and more resilient.

Congress is a drunken sailor when it comes to spending, and Chairman Bernanke needs to start taking away the bottle more and more by being more reluctant and then by outright refusing to cut interest rates at the first sign of economic troubles. Congress needs to start taking responsibility for the effects its habits have on the economy.
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Are Republicans Really More Scrambled Than Democrats?

Posted by on Wednesday, January 16, 2008 8:58:43 PM
I'm not so sure why everyone thinks the Republican primary is a five-man race at this point. Yes, there are still five men in the race who have the potential to win at least something in the next few weeks, but I can't imagine anyone outside of former Mayor Rudy Giuliani (R-NY), Sen. John McCain (R-AZ) and former Gov. Mitt Romney (R-MA) winning the nomination. All John Dickerson at Slate sees, however, is chaos:

"So we're back to square one in the Republican Party. Mitt Romney beat John McCain handily in Michigan, which means there have now been three major GOP contests and three different comeback winners. At this rate, Thompson will win South Carolina and Giuliani Florida. The GOP primary is starting to look like a Pee Wee soccer tournament: Everyone gets a trophy!"

Very clever, but slow down. Deep breaths. Does anyone actually think that former Sen. Fred Thompson (R-TN) will win South Carolina and that Mayor Giuliani will win Florida? Maybe one of those things happens, but I'd be floored if both happened, and I really don't see either one happening in the first place. That's not to say either is impossible, but both these guys had better shake the lead out yesterday if they want a win in either state.

Right now in South Carolina, RealClearPolitics has Sen. McCain in first at 26.4 percent, followed by former Gov. Mike Huckabee (R-AR) with 23.0 percent and Gov. Romney at 14.8 percent. Where's Sen. Thompson? Back in fourth with 10.4 percent. Yes, he doubles Mayor Giuliani's support, which falls below even Rep. Ron Paul's (R-TX), but still. Sen. Thompson needs some fireworks to pull off a surprise by exceeding expectations.

Gov. Romney will probably win Nevada--RCP has him up by 7.0 percent and he thinks he can get it--but since no one else is playing seriously there, it may not mean much. At the same time, however, Gov. Romney would be able to claim that he's gone 3-5 in Iowa, New Hampshire, Wyoming, Michigan and Nevada, and come in second whenever he didn't "win the gold." Mathematically, that's the best in the field. It may not get him any kind of a bounce in South Carolina, and he may not even compete seriously there, but if he somehow pulled ahead of Gov. Huckabee, then ol' Huck would be dead in the water, given the larger percentages of social conservatives and evangelicals voting in South Carolina than in New Hampshire or Michigan.

Regardless of whether that happens, I think Sen. McCain probably takes South Carolina, which at least puts Gov. Huckabee on life-support, because he needs an outright win. It probably hurts him enough going into Florida that Gov. Romney should be able to slide into third based on that alone, and maybe Gov. Romney sees more movement in the polls if he spends more time and resources in Florida than South Carolina anyway. Another silver isn't out of the question. At that point, I think it we're back where we started the summer, with Rudy McRomney all vying for the top job.

That said, I don't buy into Mayor Giuliani's strategy. The Wall Street Journal seems to think that last night's real winners were Mayor Giuliani and Sen. Thompson because a third candidate won in as many major contests. Okay, but let's remember that Mayor Giuliani finished behind Rep. Paul in Iowa and Michigan, and he's polling below Rep. Paul in South Carolina. Yes, he's got them right where he wants them... Sooner or later people have to start comparing his string of defeats to Gov. Romney's consistent first- and second-place finishes, and that can't look good going into February 5th, especially when he doesn't have the money or the organization to counter it. Mayor Giuliani can't keep that story out of the press forever, and maybe not even until after Florida.

You can play these scenarios out so many different ways, but I'm starting to think the Republican primary is going to boil down to a McCain v. Romney match-up sooner than we realize.

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Romney's Victory Speech

Posted by on Tuesday, January 15, 2008 9:36:14 PM
Former Gov. Mitt Romney (R-MA) is giving his victory speech right now. It's early, but it seems like he's doing a pretty good job changing the tone of the campaign. This business about Michigan's vote being a comeback for America was a nice touch. Saying Michigan rejected tired old Washington insider pessimism was a pretty good shot at Sen. John McCain (R-AZ), too.

This whole "They haven't!" chant can stop, though. As much as I like Gov. Romney, it just doesn't work. He has a lot better luck talking about the Democrats bringing change, just not the change we want. He had a good line about Democrats admiring the Europe of old, big government, big brother and big taxes. According to Gov. Romney, they think American is great because we have a great government. He then pivoted pretty nicely to pay homage to former Presidents Ronald Reagan and George H. W. Bush. Passing over the current President Bush probably wasn't a bad idea, especially if Gov. Romney plans on turning a weakening economy into his strength and Sen. McCain's weakness.

I thought Gov. Romney's speech was a little short. His concession speech after New Hampshire was actually more impressive, in my opinion at least. I guess he didn't really need to hit a home run with his speech, however, since with 25 percent reporting in, he's now up by a good nine points or so, and he preempted Sen. McCain by starting his speech just as Sen. McCain was warming up.

Still, Fred Barnes is making some good points on the air right now. Sen. McCain read his speech in New Hampshire and gave what I thought was a disastrous performance. It was like listening to someone reading a bedtime story. In contrast, tonight Gov. Romney wasn't even wearing his jacket, and his hair was messed up. Mr. Barnes thinks Gov. Romney was excited as a child and more real. Maybe he's starting to get comfortable out there.
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FOX News Calls Michigan for Romney!

Posted by on Tuesday, January 15, 2008 9:17:44 PM
FOX News has called Michigan for former Gov. Mitt Romney (R-MA). Obviously, the margins aren't certain, since only about 15 percent of precincts have reported in so far. Still, I'm glad Gov. Romney has another win under his belt.

Mort Kondracke of Roll Call just made some good points on the air. He noted that Gov. Romney really changed gears coming out of New Hampshire, leaving behind the issues and messages he'd been hammering McCain on. Romney hasn't be preaching laissez faire economics in Michigan; he's been promising a lot of government intervention to get Detroit back on track. While I may think that's the wrong policy approach, Mr. Kondracke is right that the Romney campaign did a good job figuring out what Michiganders were worried about and addressing it. Gov. Romney painted himself as a turnaround artist from the business world and the Olympics and he turned around his campaign by promising to turn around Michigan.

Former Gov. Mike Huckabee (R-AR) is giving his concession speech right now. He hasn't said anything I really disagree with, but for some reason, I'm just not impressed. I don't like his record on pardons, taxes or accepting gifts. He just rubs me the wrong way, and I don't trust him.
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Teaching the Freedom to Choose

Posted by on Tuesday, January 15, 2008 7:23:52 PM
David Strom's take on European indoctrination in an anti-free market ideology really got my attention. I'm only a semester away from earning a B.S. in economics and a B.A. in political science, and the difference between the quality of education I received in each program is startling. In our political science program, we're pretty much told to act like condescending spectators, asking why those stupid, ignorant members of the American public aren't doing what they should be doing or voting the way they should be voting. I'll give you two guesses as to why I find that way of thinking offensive, but you shouldn't need more than one.

At the same time, my education in economics really changed my way of looking at the world. As soon as you admit that people make rational decisions based upon their priorities and that the government can't possibly have as good an idea of what's best for individuals as those individuals can, then the idea of government protecting people from themselves by providing for them seems kind of nuts. In fact, it seems downright dangerous.

I go to a very liberal university in Washington, D.C. People's jaws drop when I tell them I was a hardcore Democrat when I first set foot on campus at age 18, because within less than a year, I had become a pretty conservative Republican. Most of the professors are pretty liberal--although at least the economics professors are very fair and unbiased--so it's ironic that I somehow managed to reject the dominant ideology on campus. I don't know how often that happens, but if there were a little more academic freedom and intellectual diversity on campuses, then we'd probably all be better off.

Nevertheless, a problem I've already started running into is that its difficult for me to communicate what I've learned to anyone who doesn't have the benefit of four years of economics under his belt. Part of that is inevitable, since I've been stuck in an ivory tower for four years and trying to talk to someone who still lives in the real world isn't the easiest thing anymore. Still, some of the ideas of people from Adam Smith to Milton Friedman appear obvious to us only in hindsight, and I wish I would have had more exposure to some basic economics when I was in high school.

I think everyone should. If we're going to be deciding presidential elections based on "the economy, stupid," then high school seniors should be taking not just a course in American government, but also one in economics. My old high school in Cincinnati has courses in pottery-making, gourmet cooking and fashion design, but to my knowledge, no basic course in economics. Maybe if we could inject some real market competition into government education, then the market would eliminate a lot of the fluff and replace it with the substantive education that we need to be good citizens.
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Why America Needs a Little Less Barney Frank

Posted by on Monday, January 14, 2008 6:32:16 PM
I can't stand when knowledgeable politicians who should know better exploit the public's lack of understanding of very complex problems for political gain. In yesterday's Financial Times, Rep. Barney Frank (D-MA), chair of the House Financial Services Committee, did just that, arguing that America needs more--not less--regulation:

"As we prepare for this autumn’s election, the results are in on America’s 30-year experiment with radical economic deregulation. Income inequality has risen to levels not seen since the 1920s and the collapse of the unregulated portion of the mortgage and secondary markets threatens the health of the overall economy."

Rep. Frank was telling the truth in that excerpt, but not the whole truth. Yes, the results are in on America's 30-year experiment with much-needed economic deregulation, but they are decidedly positive. Yes, income inequality has risen to levels not seen since the 1920s, but whether that's a bad thing is less clear, and what, if anything, the government should do about it still less. Yes, the unregulated portion of the mortgage market is threatening the health of the overall economy, but Congress and the Federal Reserve are likely more responsible than any mysterious market excesses.

Libertarians love deregulation, and I'd be lying if I said I was an exception. I have a sneaking suspicion that we could privatize the U.S. Postal Service and see massive improvements in service and long-term reductions in the real price of service. My sense of government education is much the same. If we want to look at an example of an industry that we actually deregulated, however, then the airline industry is a good case in point. Service improved and fares fell. Admittedly, larger airlines still engage in flagrantly anti-competitive practices, but only because earlier over-regulation protected them and gave them the unnatural size necessary to do it. Over time, however, bloated companies like Delta will fail and nimble companies like Southwest will prevail. Without deregulation in the airline industry, we would all be a lot worse off.

But let's forget about the libertarian causes celebres and turn our attention to Rep. Frank's own backyard. I wonder what Rep. Frank would say about how successful Sarbanes-Oxley (SOX) has been in forcing publicly traded companies to delist from the major American exchanges? The Securities and Exchange Commission now requires companies to meet such high auditing standards before they can list on the major exchanges that for many companies, SOX has become a prohibitively high barrier to entry into capital markets. That's a problem because when companies cannot leverage capital markets, they are forced to pay higher interest rates on loans because they cannot spread risk across as large a pool of investors. They cannot expand and innovate as quickly and economic growth and increases in the standard of living slow. Is it any wonder that the London Stock Exchange now boasts more initial public offerings a year than the New York Stock Exchange?

It's awfully convenient for Rep. Frank to argue that the market is leaving some people behind while his committee's laws restrain the income-boosting potential of the market, but some day I would like to hear a liberal make a compelling argument as to why income inequality is a bad thing. There is a compelling argument to be made, but all I ever hear from liberals is that it isn't fair for some people to have more than others. That's nuts. Bill Gates makes a lot more money than I do, and that may be unequal, but it's completely fair because he's a much more productive individual than I am. He produces software that makes people's lives better while I produce blog posts, so he has earned his money, and I don't begrudge him that. Complaining that someone has more than me simply because he does sounds a lot like, "Mommy, Daddy, he has more than me! She has more than me! Give me more!." It's a childish waste of time.

Here's the argument liberals like Rep. Frank should be making. When an individual amasses such a fortune that he has the market power to distort price signals, then income inequality may be a problem. Mr. Gates, instead of engaging in meaningful philanthropic work, could have offered all the homebuilders in America tons of money to build a Tower of Babel in the middle of the state of Washington. The result would have been higher building costs for very useful homes for the average American relative to costs for the useless second Tower of Babel. The conclusion, however, is not more regulation but less. Should we tax away all of Mr. Gates' wealth and discourage others from innovating and becoming more productive? Of course not. Instead, we should deregulate government education, from kindergarten on up through graduate school, so the real price of an education falls over the long term and more people have the opportunity to become as productive as Mr. Gates.

Finally, blaming the housing crisis on market excesses is one of the greatest cop-outs ever. In Alan Greenspan's new book, The Age of Turbulence, he describes the Federal Reserve's decision to leave interest rates low throughout the late 1990s. The Fed thought that increases in information technology were increasing productivity to the point where the country might actually need and be able to absorb a larger monetary base. Mr. Greenspan admits that leaving rates too low, however, carried with it the risk of creating a housing bubble but that he thought the benefits of broad homeownership to democracy outweighed that risk.

This is one of few times when I must respectfully disagree with Mr. Greenspan. Yes, broad homeownership is a very good thing, but when we leave interest rates artificially low, we are deceiving buyers into thinking they can afford homes when they really can't and setting them up for failure. A much larger housing bubble developed before the Great Depression because the Fed left interest rates artificially low to help prop up the overvalued British pound. When inflation picked up, the Fed raised rates and people lost their homes. The same thing is happening today. Rather than using interest rates to micromanage the economy, the Fed should concern itself simply with controlling inflation and protecting the value of the dollar. Refusing to indulge irresponsible lawmakers on Capitol Hill with an accommodative monetary policy would force Congress to pay down the national debt, stop running deficits and reduce the size of government over the long term. The result would be lower and more stable interest rates, making confusing and opaque lending vehicles like adjustable-rate and interest-only mortgages less risky for buyers and therefore less attractive to lenders, and probably fewer foreclosures, too. Rep. Frank can regulate the housing market and the lending industry all he likes, but all that amounts to is a refusal to take responsibility for Congress's own actions.

I am very apprehensive about the coming election because I think Democrats might be able to ride the waves of the perfect storm. Mr. Greenspan was right that market capitalism increases anxiety because it exposes us to creative destruction and forces us to innovate constantly, but in exchange for that anxiety, we all enjoy a higher standard of living. Tapping into that anxiety and leveraging it to produce more regulation and less freedom will only hurt us all. Rep. Frank wants to do just that in the capital markets, and all the Democrats want to do it in health care. It's irresponsible and experienced policymakers like Rep. Frank should know better. Centralized, one-size-fits-all regulation at the federal level is the essence of arrogance. Why on Earth would we ever want to make it illegal for anyone else in the room to have a better idea?
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