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.