The United States economy is recovering far more slowly from the 2008 financial crisis than from any previous recession since the end of World War II. The rate of economic growth is way below trend and the rate of unemployment, properly defined, is way above its natural level and shows no sign of any decline.
The forces behind this slow recovery most assuredly include neither a shortage of base money nor excessively high rates of interest.
U.S. banks have $1.5 trillion in cash on their balances sheets in excess of their legally required reserves. That is far more than enough to meet any unsatisfied demand for loans considered by bankers to satisfy the conditions of prudence. In the summer of 2010, the Federal Reserve added $600 billion to banks’ reserves by purchasing federal Treasurys and mortgage-backed securities. In June 2012, $500 billion of those reserves remain on U.S. bank balance sheets, while most of the rest lie in the vaults of foreign banks.
Meanwhile, market interest rates on all maturities of government bonds are the lowest since the founding of the republic. With mortgage rates lower than ever in history, and housing showing at best very sluggish recovery, dropping the mortgage rate another fraction is useless. Business investment also is unlikely to be augmented by some fractional reduction in borrowing costs.
The 800 pound gorillas in the nation’s market place are fiscal not monetary in nature. Businesses simply will not invest in a climate of uncertainty wherein they will have no idea of next year’s tax rates, health care costs and regulatory burdens until after November 6, 2012. Many businesses, in any event, are exercising a capital strike until the current administration is out of office. Consumers will not increase their expenditures while uncertainties remain about their tax burdens and health care responsibilities. The economy as a whole shudders under the realization that elected officials ignore a major public debt crisis and allow the debt to increase unabated at the rate of $4 billion per day.
None of these problems are amenable to monetary policy, be it through interest rate cuts – virtually impossible – or through quantitative easing. Surely even a blinkered Harvard economist such as Ben Bernanke can dimly understand this line of economic reasoning.
What can be impacted by such inappropriate monetary expansion, however, is the rate of price inflation across the nation. Markets already perceive the danger. Why else would investors such as myself pay heavy premia in order to hold index-linked Treasury bonds that protect against inflation? Why else would asset holders shift the balance of their portfolios away from money in favor of equities and real assets?
By failing to understand basic economics, Ben Bernanke leads the Federal Reserve into a monetary policy that cannot conceivably save the neck of the incumbent president – which surely must be his implicit goal – but which assuredly will reintroduce, with long and variable lags, the 1970s nightmare of stagflation across the United States.
Hat Tip: Allan Meltzer, ‘What’s Wrong With the Federal Reserve’, The Wall Street Journal, July 10, 2012