|
In a lecture given at George
Washington University on March 27, 2012, the chairman of the Fed said that
the US central bank's aggressive response to the 2007–2009 financial
crisis and recession helped prevent a worldwide catastrophe.
Various economic indicators were
showing ominous signs at the time. After closing at 3.1 percent in September
2007, the yearly rate of growth of industrial production fell to minus 14.8
percent by June 2009. The yearly rate of growth of housing starts fell from
20.5 percent in January 2005 to minus 54.8 percent in January 2009.
 
Also, retail sales came under
severe pressure — year on year, the rate of growth fell from 5.2
percent in November 2007 to minus 11.5 percent by August 2008. The
unemployment rate jumped from 4.4 percent in March 2007 to 10 percent by
October 2009. During this period, the number of unemployed people increased
from 13.389 million to 15.421 million — an increase of 2.032 million.
In response to the collapse of the
key economic data and a fear of a financial meltdown, the US central bank
aggressively pumped money into the banking system. As a result, the Federal
Reserve balance sheet jumped from $0.884 trillion in February 2008 to $2.247
trillion in December 2008. The yearly rate of growth of the balance sheet
climbed from 1.5 percent in February 2008 to 152.8 percent by December of
that year. Additionally the Fed aggressively lowered the federal-funds rate
target from 5.25 percent in August 2007 to almost nil by December 2008.
Despite this pumping, the growth
momentum of commercial-bank lending had been declining with the yearly rate
of growth falling from 11.9 percent in January 2007 to minus 5.3 percent by
November 2009. As a result of the fall in the growth momentum of lending, the
growth momentum of the money supply would have followed suit if not for the
Fed's aggressive pumping to the commercial paper market. This pushed the
yearly rate of growth of our measure of US money supply from 1.5 percent in
April 2008 to 14.3 percent by August 2009.
In his speech Bernanke blamed
reckless lending in the housing market and financial engineering for the
economic crisis. He also acknowledged that the supervision by the Fed was
inadequate. According to Bernanke, once the crises emerged the Fed had to act
aggressively in order to prevent the crisis from developing into a serious
economic disaster. The Fed chairman holds that a highly accommodative
monetary policy helps support economic recovery and employment.
We hold that various reckless
activities in the housing market couldn't have emerged without the Fed's
previous reckless policies. After closing at 6.5 percent in December 2000,
the federal-funds rate target was lowered to 1 percent by May 2004. The
yearly rate of growth of our monetary measure, AMS, jumped from minus 0.9
percent in December 2000 to 11.5 percent by December 2001. In short, the
strong increase in the growth momentum of money supply coupled with an
aggressive lowering of interest rates set the platform for various bubble
activities, or an economic boom.
A reversal of the Fed's loose
stance put an end to the false boom and put pressure on various bubble
activities. The federal-funds-rate target was lifted from 1 percent in May
2004 to 5.25 percent by June 2006. The yearly rate of growth of AMS plunged
from 11.5 percent in December 2001 to 0.6 percent in May 2007. As it
happened, the effect of this tightening was felt in the housing market first
before it spilled over to other bubble sectors. (A tighter monetary stance
slowed down the diversion of real savings toward bubble activities from
wealth-generating activities.)
Contrary to Bernanke, we suggest
that his loose monetary policy of August 2007 didn't save the US economy but
saved various bubble activities that had come under pressure from the
previous tighter monetary stance.
Note the loose monetary stance has
been aggressively diverting real funding from wealth generators towards
bubble activities, thereby weakening the wealth-generation process. The only
reason why loose monetary policy supposedly "revived" the economy is
because there are still enough wealth generators to support the Fed's
reckless policy. Also, note that all the gains from the previous tighter
stance have now been wasted to support bubble activities.
As long as the pool of real savings
is still growing, Fed policy makers can get away with the illusion that they
have saved the US and the world economies. Once the pool of real savings
starts stagnating, or worse, declining, the illusory nature of the Fed's
policy will be revealed — note that the economy follows the state of
the pool of real savings. Any aggressive monetary policy in this case is
going to make things much worse.
The actions of Bernanke to revive
the economy run contrary to the basic principles of running a company. For
instance, in a company of 10 departments, 8 departments are making profits
and the other 2 losses. A responsible CEO will shut down or restructure the 2
departments that make losses — failing to do so will divert funding
from wealth generators toward loss-making departments, thus weakening the
foundation of the entire company. Without the removal or restructuring of the
loss-making departments, there is the risk that the entire company could
eventually go belly up. So why then should a CEO who decides to support nonprofitable activities be regarded as a failure when
Bernanke and his central-bank colleagues are seen as heroes who saved the
economy?
Bernanke is of the view that by
pumping money he has provided the necessary liquidity to keep the financial
system going. We suggest that this is false. What permits the financial
sector to push ahead is real savings. The financial sector does not have a
life of its own; its only role is to facilitate the real wealth that was
generated by the wealth producers. Remember that banks are just intermediaries;
they facilitate real savings across the economy by means of money (the medium
of exchange).
By flooding the banking system with
money, one doesn't create more real savings but, on the contrary, depletes
the pool of real funding. Most commentators are of the view that in some
cases when there is a threat of serious damage to the financial system the
central bank should intervene to prevent the calamity, and this is precisely
what Bernanke's Fed did.
We suggest the severe threat here
is to various bubble activities that must be removed in order to allow wealth
generators to get on with the job of creating wealth. If a lot of bubbles
must disappear, so be it. Any policy to support bubbles, be it large banks or
other institutions, will only make things much worse. As we have seen, if the
pool of real savings is not there, a central-bank policy to prop up bubbles
will make things much worse. After all, the Fed cannot generate real wealth.
Bernanke's policy — which
amounts to the protection of inefficiency, i.e., bubble activities —
runs the risk of generating a prolonged slump with occasional rallies in the
data. It could be something similar to the situation in Japan (which Bernanke
has in the past criticized).
Summary and Conclusion
We can conclude that, contrary to
Bernanke, his loose policies didn't save the US economy from a depression but
have instead damaged the process of real wealth generation.
Bernanke's loose policies have
provided support to bubble activities, thereby destabilizing the economy. So
in this sense his policies have saved the bubbles, thus undermining wealth
generators.
We suggest that the more forceful
the Fed's response to various economic indicators is, the more damage this
does to the pool of real savings. This runs the risk that at some stage the
United States could end up having a stagnating or worse, declining, pool of
real savings.
If this were to occur, then we
could end up of having a severe economic slump. If anyone needs examples in
this regard, have a look at countries such as Greece, Spain, and Portugal.
Over a prolonged period of time the
policies of these countries (an ever-growing government and central-bank
involvement in the economy) have severely damaged the heart of economic
growth — the pool of real savings.
Again, if the pool of real savings
is to become stagnant, or worse, starts declining, any attempt by the Fed to
make things better is going to make things actually much worse by depleting
the pool of real savings or funding further. If the pool of real funding is
stagnating, then no matter how much pumping the Fed does, banks will not be
able to lift lending. Remember: without expanding real funding any expansion
in credit could lead to financial disaster.
|
