FT Recommends Shotgun for Serial Killer

Greenspan's Folly

President Obama has poured calming oil on the turbulent financial markets by announcing early his reappointment of Ben Bernanke to the Federal Reserve Chairmanship.

What he hasn’t done is explain how he will prevent the Fed from causing another global financial crisis. Which of course is not how many pundits see it.

Having been litter-trained by the media to blame the crisis on the banks, they obediently repeat the party line that what is needed is more power for the Fed to keep the evil bankers in line.

This fallacy is the thrust of this uncomfortably trite article from the FT. We beg to differ. The crisis saw an unprecedented coincidence of bubbles: an oil price bubble, a real estate bubble, a stock market bubble and a commodity price bubble simultaneously. This can happen only when cheap, plentiful money is chasing every asset in sight.

It’s like brothel prices when when a boatload of lonely sailors comes ashore. And in this case, the price (and quantity of money) was controlled not by the banks, but by the Fed.

Alan Greenspan’s low interest rates between 2000 and 2004 (see chart) were an overreaction to the 2000/2001 recession. As money poured in from China to boost the flood of cheap funds, there was no-one to tell Greenspan to raise rates and curb the flood: the Fed is an unaccountable, powerful cabal ruled by an omnipotent Chairman. Curbing this power should be the real focus of reform.

Cheap Money-but to what end?

Holding back the flow

The markets fidgeted nervously over the past two days, as the Fed met in secret conclave to deliberate on the direction of monetary policy.

It needn’t have worried: The Fed Funds rate, which influences all other US interest rates, remains at essentially zero. With U.S. unemployment now at a disturbing 9.5%, the Fed fears that curbing the flow of cheap money might constrain investment and spending, and plunge the already feeble economy into the waiting arms of the Grim Reaper.

The Bank of England Chairman agrees. With the key UK interest rate at a similar level of 0.5%, the Chief Money Man paints a gloomy picture of the economy’s prospects. With unemployment now at 2.4 million Britons or 7.6%, the faltering monetary system needs all the boost the BoE can muster.

Or so the conventional wisdom goes. Like the massively unaffordable bailouts, this loose monetary policy is a short-term band-aid with potentially dire future consequences. By keeping interest rates low, central bankers are encouraging consumers to maintain high debt levels. Unaffordable mortgages and credit card debt remains unpaid. Eventually, interest rates will have to rise- and the burden of their repayment will be even heavier then.

It would be more merciful to gradually raise interest rates now. This would hasten the return of house prices to normal levels, force weak borrowers into bankruptcy and purge bank balance sheets of bad loans in one swift, bloody pass. The sooner the purge, the quicker the recovery.