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New York Times
October 26, 2005
Op-Ed Contributor
Future Shock at the Fed
By JAMES GRANT
PRESIDENT BUSH's choice to succeed Alan Greenspan as chairman of the Federal Reserve Board has raised a roar of approval. Economist, scholar, presidential counselor and former Fed governor, Ben S. Bernanke is a nominee from central casting.
But there is one rub. The man with the gray beard and the perfect résumé - winner of the South Carolina state spelling bee, Ph.D. from the Massachusetts Institute of Technology, former chairman of the Princeton economics department - professes to believe the impossible. He insists that the Fed can keep the economy chugging and prices stable just by pushing a single interest rate (the so-called federal funds rate) up and down.
Alan Greenspan, of course, has long espoused the same impossibility, as have other Federal Reserve officials and many private economists. A little thought experiment will reveal their error.
Let us say that Mr. Bernanke's field of expertise was energy prices rather than interest rates, and that the president named him to the Department of Energy rather than the Federal Reserve. If Mr. Bernanke then ventured a long-term oil-price forecast, would anyone even bother to write it down? Would anyone expect him, once confirmed, to actually fix the price?
Those who did would have to call the idea by its discredited name - price controls - and would have to explain why the secretary-designate knew better than the market at which price the supply of oil would meet the demand for oil. They would also have to explain why this episode in price controls would turn out better than the long series of flops that preceded it. The world would laugh.
Yet we seem to accept, and even desire, exactly such ludicrous claims of foresight from a Fed chairman. It follows that anyone who is willing to take the job as Fed chief is, by that reason, unqualified to hold it.
Wall Street, of course, has other ideas. Thus the rally in stock prices following word of Mr. Bernanke's nomination was no vote of confidence that the presumptive chairman would settle on the right, or true, federal funds rate. It was, rather, an expression of hope that he would do his all to ensure a speculatively appropriate (meaning very, very low) rate.
Perhaps. But Mr. Bernanke's history shows he is not so much a believer in easy money as in the capacity of the Fed to take the right anticipatory action. Is the rate of inflation too high? Not high enough? With a twist of the monetary-policy dial, the problem is on its way to being solved. Let the Fed announce its target for inflation - say, 2 percent a year - and juggle its interest rate to cause that desired inflation rate to materialize. In so many words, the nominee contends, policymakers control events, rather than the other way around.
We are all susceptible to believing an impossible thing. Mr. Bernanke has the special susceptibility of the straight-A student. The economic world he sees is his to command. He can comprehend it, even measure it (no small achievement given the subjective, even arbitrary, nature of statistical sampling and compilation). And he expresses his supreme self-confidence in some of the bluntest language ever spoken by a central banker.
Late in 2002, the Fed started to warn against the risk of deflation, that is, of broadly falling prices. Now, deflation is no bad thing if you find yourself at the cash register with a shopping cart full of groceries. But Mr. Bernanke did not have the shopper exclusively in mind. "When inflation is already low and the fundamentals of the economy suddenly deteriorate," he said in a speech that November, "the central bank should act more pre-emptively and more aggressively than usual in cutting rates."
Some modicum of inflation is a must, he said. Let prices start to sag, and they could go right on sagging, as they had done in Japan for years. The solution: print money. The counterarguments for sitting tight (Are not falling prices a natural and, on balance, benign consequence of the incorporation of China and India into the global economy? By printing extra money to prop up the American inflation rate, wouldn't the Fed distort a whole host of prices and interest rates?) found no sympathy with him or Mr. Greenspan.
So Mr. Bernanke, then one of seven Federal Reserve governors, sought to assure the world that United States monetary policy would stop deflation before it started. Yet here was a tricky assignment, for the post-1971 dollar is purely faith-based. Not since the Nixon years has a holder of dollars had the privilege of exchanging them for a statutory weight of gold. Rather, the dollar is a piece of paper, or electronic impulse, of no intrinsic value. It is legal tender whose value is ultimately determined by the confidence of the people who hold it.
In the Greenspan era, the United States became an immense net debtor. A prudent American central banker, it might seem, would therefore be at pains to spare these overseas accumulators of greenbacks any unnecessary anxiety about inflation damaging the shelf life of their money. Not Mr. Bernanke. In that 2002 speech, he said that because the currency is intrinsically worthless, the government can (and in certain circumstances should) print up as much of it as it wants. And it should not be stymied in the work of restoring the rate of inflation to a decent minimum even if interest rates fell to zero.
The Fed could, if necessary, buy up all the Treasury's debt, using dollars created specially for the purpose. Or, for a double-barrel stimulus, it could also buy up private debts (mortgages, car loans, bonds and the like). And as a last resort, the Fed could figuratively put in place an idea that the economist Milton Friedman once theorized for illustrative purposes: It could drop money out of helicopters. Approbation for Mr. Bernanke is not quite universal on Wall Street; after that speech some took to mockingly calling him "Helicopter Ben."
Many were the blessings, real and imagined, of the Greenspan era: low inflation, falling interest rates in a growing economy, a pair of notably mild recessions and a succession of financial crises nipped in the bud by an activist Federal Reserve. Stock prices were bubbly (until the bubble burst), and Wall Street prospered. But debt grew and grew, and the gulf between what the United States consumes and what it produces - the trade deficit - widened to break all records.
Now Mr. Bernanke stands to inherit what Mr. Greenspan and he, among others at the Fed, wrought. Certainly they have whipped deflation. But by pressing down interest rates to the floor, they have pushed housing prices to the sky. And they are the uneasy witnesses to an unscripted climb in the Consumer Price Index, which, in September, registered a 4.7 percent increase over last year.
Don't worry, many counsel. The seemingly alarming inflation data are the statistical tracks of a boom in energy prices caused by the Iraq war and the Gulf Coast hurricanes. It will pass.
But what if it doesn't? What if a new cycle of rising prices has already begun - as I happen to believe it has? Mr. Bernanke, as sure of himself as he is of the future, won't soon be changing the way the Fed operates. Rather, it will be the world's dollar holders who will change the way they operate.
If America's creditors sense that inflation is robbing them of their wealth and that the Bernanke Fed is too slow to raise its interest rate, they will sell their dollars and dollar-denominated securities. Such an exodus would, among other things, tend to increase the costs of imported goods and drive up dollar-denominated interest rates. In other words, events would control the Fed.
Since each of the world's major currencies is a scrap of paper of no intrinsic value, some of these disaffected dollar investors may buy gold. Mr. Bernanke doesn't talk much about that barbarous relic. What would he make of a flight from a rationally managed currency into an inert precious metal? I will guess that it would astonish him.
James Grant, the editor of Grant's Interest Rate Observer, is the author of "John Adams: Party of One."
October 26, 2005
Op-Ed Contributor
Future Shock at the Fed
By JAMES GRANT
PRESIDENT BUSH's choice to succeed Alan Greenspan as chairman of the Federal Reserve Board has raised a roar of approval. Economist, scholar, presidential counselor and former Fed governor, Ben S. Bernanke is a nominee from central casting.
But there is one rub. The man with the gray beard and the perfect résumé - winner of the South Carolina state spelling bee, Ph.D. from the Massachusetts Institute of Technology, former chairman of the Princeton economics department - professes to believe the impossible. He insists that the Fed can keep the economy chugging and prices stable just by pushing a single interest rate (the so-called federal funds rate) up and down.
Alan Greenspan, of course, has long espoused the same impossibility, as have other Federal Reserve officials and many private economists. A little thought experiment will reveal their error.
Let us say that Mr. Bernanke's field of expertise was energy prices rather than interest rates, and that the president named him to the Department of Energy rather than the Federal Reserve. If Mr. Bernanke then ventured a long-term oil-price forecast, would anyone even bother to write it down? Would anyone expect him, once confirmed, to actually fix the price?
Those who did would have to call the idea by its discredited name - price controls - and would have to explain why the secretary-designate knew better than the market at which price the supply of oil would meet the demand for oil. They would also have to explain why this episode in price controls would turn out better than the long series of flops that preceded it. The world would laugh.
Yet we seem to accept, and even desire, exactly such ludicrous claims of foresight from a Fed chairman. It follows that anyone who is willing to take the job as Fed chief is, by that reason, unqualified to hold it.
Wall Street, of course, has other ideas. Thus the rally in stock prices following word of Mr. Bernanke's nomination was no vote of confidence that the presumptive chairman would settle on the right, or true, federal funds rate. It was, rather, an expression of hope that he would do his all to ensure a speculatively appropriate (meaning very, very low) rate.
Perhaps. But Mr. Bernanke's history shows he is not so much a believer in easy money as in the capacity of the Fed to take the right anticipatory action. Is the rate of inflation too high? Not high enough? With a twist of the monetary-policy dial, the problem is on its way to being solved. Let the Fed announce its target for inflation - say, 2 percent a year - and juggle its interest rate to cause that desired inflation rate to materialize. In so many words, the nominee contends, policymakers control events, rather than the other way around.
We are all susceptible to believing an impossible thing. Mr. Bernanke has the special susceptibility of the straight-A student. The economic world he sees is his to command. He can comprehend it, even measure it (no small achievement given the subjective, even arbitrary, nature of statistical sampling and compilation). And he expresses his supreme self-confidence in some of the bluntest language ever spoken by a central banker.
Late in 2002, the Fed started to warn against the risk of deflation, that is, of broadly falling prices. Now, deflation is no bad thing if you find yourself at the cash register with a shopping cart full of groceries. But Mr. Bernanke did not have the shopper exclusively in mind. "When inflation is already low and the fundamentals of the economy suddenly deteriorate," he said in a speech that November, "the central bank should act more pre-emptively and more aggressively than usual in cutting rates."
Some modicum of inflation is a must, he said. Let prices start to sag, and they could go right on sagging, as they had done in Japan for years. The solution: print money. The counterarguments for sitting tight (Are not falling prices a natural and, on balance, benign consequence of the incorporation of China and India into the global economy? By printing extra money to prop up the American inflation rate, wouldn't the Fed distort a whole host of prices and interest rates?) found no sympathy with him or Mr. Greenspan.
So Mr. Bernanke, then one of seven Federal Reserve governors, sought to assure the world that United States monetary policy would stop deflation before it started. Yet here was a tricky assignment, for the post-1971 dollar is purely faith-based. Not since the Nixon years has a holder of dollars had the privilege of exchanging them for a statutory weight of gold. Rather, the dollar is a piece of paper, or electronic impulse, of no intrinsic value. It is legal tender whose value is ultimately determined by the confidence of the people who hold it.
In the Greenspan era, the United States became an immense net debtor. A prudent American central banker, it might seem, would therefore be at pains to spare these overseas accumulators of greenbacks any unnecessary anxiety about inflation damaging the shelf life of their money. Not Mr. Bernanke. In that 2002 speech, he said that because the currency is intrinsically worthless, the government can (and in certain circumstances should) print up as much of it as it wants. And it should not be stymied in the work of restoring the rate of inflation to a decent minimum even if interest rates fell to zero.
The Fed could, if necessary, buy up all the Treasury's debt, using dollars created specially for the purpose. Or, for a double-barrel stimulus, it could also buy up private debts (mortgages, car loans, bonds and the like). And as a last resort, the Fed could figuratively put in place an idea that the economist Milton Friedman once theorized for illustrative purposes: It could drop money out of helicopters. Approbation for Mr. Bernanke is not quite universal on Wall Street; after that speech some took to mockingly calling him "Helicopter Ben."
Many were the blessings, real and imagined, of the Greenspan era: low inflation, falling interest rates in a growing economy, a pair of notably mild recessions and a succession of financial crises nipped in the bud by an activist Federal Reserve. Stock prices were bubbly (until the bubble burst), and Wall Street prospered. But debt grew and grew, and the gulf between what the United States consumes and what it produces - the trade deficit - widened to break all records.
Now Mr. Bernanke stands to inherit what Mr. Greenspan and he, among others at the Fed, wrought. Certainly they have whipped deflation. But by pressing down interest rates to the floor, they have pushed housing prices to the sky. And they are the uneasy witnesses to an unscripted climb in the Consumer Price Index, which, in September, registered a 4.7 percent increase over last year.
Don't worry, many counsel. The seemingly alarming inflation data are the statistical tracks of a boom in energy prices caused by the Iraq war and the Gulf Coast hurricanes. It will pass.
But what if it doesn't? What if a new cycle of rising prices has already begun - as I happen to believe it has? Mr. Bernanke, as sure of himself as he is of the future, won't soon be changing the way the Fed operates. Rather, it will be the world's dollar holders who will change the way they operate.
If America's creditors sense that inflation is robbing them of their wealth and that the Bernanke Fed is too slow to raise its interest rate, they will sell their dollars and dollar-denominated securities. Such an exodus would, among other things, tend to increase the costs of imported goods and drive up dollar-denominated interest rates. In other words, events would control the Fed.
Since each of the world's major currencies is a scrap of paper of no intrinsic value, some of these disaffected dollar investors may buy gold. Mr. Bernanke doesn't talk much about that barbarous relic. What would he make of a flight from a rationally managed currency into an inert precious metal? I will guess that it would astonish him.
James Grant, the editor of Grant's Interest Rate Observer, is the author of "John Adams: Party of One."
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