At the Fed, 'Success' Is About Limiting Its Damage
In congressional testimony last week, newly minted Fed Chairman Janet Yellen ably revealed why the central bank she runs is often such an imposing barrier to economic progress. While it will be explained later in the piece why Yellen will ultimately have a successful Fed tenure in a debased, "soft bigotry of low expectations" sense, her testimony makes clear that she'll succeed despite her impressive weakness as an economic thinker.
Responding to Sen. Tom Coburn's skepticism about the Fed's zero rate policies, Yellen said "The reason we have low interest rates is to deal with a very real problem, namely the economy is operating significantly short of its potential." Where does one begin?
What an admission from the new Chair of the world's foremost central bank. Indeed, if we accept for a moment the silly idea that the Fed should be responsible for economic growth, and Yellen accepts just that, her response to Coburn was an explicit acknowledgement that the Fed's policies these last several years have gifted us with an economy that is "operating significantly short of its potential."
Implicit in a zero rate of interest vainly set by the Fed is that yes, its economic program hasn't worked. Why else, if we're looking through the Fed's blurry economic lens, would the rate be at zero unless the Fed's policies had explicitly failed?
To see why, we need only reverse the logic of Yellen's confused response to Coburn. If the fed funds rate sits at zero because the economy is "operating significantly short of its potential," then we can conclude that if the economy were "operating significantly beyond its potential" in the Keynesian way that the Fed analyses things, that the short rate for credit set by the Fed would be quite a bit higher today.
What's important here is that we not be surprised by the Fed's shortcomings. Credit is an economic good like anything else, so just as a Ministry of Television would fail if it tried to set the proper rate of television set growth, and cost of same, so will the Fed logically fail in its attempts to manage the allocation of credit.
When readers think about the Fed and achievement, they should never think of it in the normal way they'd define success or failure. Failure is a given in that central planning of anything naturally fails. So with the Fed, "success" should be defined by how little damage its planners foist on all of us.
In Yellen's case, if we accept the Twilight Zone world we inhabit in which we empower the supposedly "wise men" on the Federal Open Market Committee (FOMC) to set the short rate for credit, we must conclude that the allegedly bright individuals who populate the FOMC must be exceedingly dim. That is so because the last thing any reasonable government bureaucrat would do amid a presumed shortage of anything would be to decree it cheap, or in the Fed's case, free.
That's the case because high prices, by definition, beget low prices. More to the point, high prices of anything signal to entrepreneurs what the markets want more of, while low prices often signal the opposite. If credit is tough to attain, then a wise Federal Reserve would float the fed funds rate, and let it go as high as the markets dictate. If so, high rates would serve as a lure to those with access to the economy's resources to offer it at a remunerative rate of return. The Yellen Fed gets it backwards.
Worse, Yellen's very attempts to boost the economy through monetary machinations serve as a barrier to actual growth. Lest we forget, recessions, painful as they are, are merely a sign that an economy comprised of individuals is fixing itself. Recessions are when bad investments, poor misuses of labor, and ill-conceived businesses are cleansed from the economy, and that's why, if left alone, recessions beget massive economic rebounds.
Recessions are the cure, and the fact that they are is another signal of the confusion that defines the Yellen Fed, along with the Bernanke Fed that preceded it. Were wise minds in control of that which doesn't work, central bankers would be most prone to step back and do nothing amid downturns so as to not limit the recession's ability to fix the economy. Sadly, wise minds don't inhabit our central bank.
The response to the above is often that some smart people do in fact work within the Fed's bureaucracy: Dallas Federal Reserve President Richard Fisher most often mentioned as one of the few Fed officials who gets it. Having seen Fisher speak, he's surely an improvement on Yellen from an economic philosophy perspective, and for those properly skeptical of the ability of the Fed to fine-tune the economy, they would probably cheer his comment last week on alleged Fed ‘stimulus', that "I believe the time to dilute the [easy money] punch is close upon us." But Fisher's very statement that would please so many reveals why he misses the point every bit as much as Yellen does.
Indeed, there's no regulatory body that presumes to dictate the availability of smartphones, so why one for credit? Assuming readers accept the role of the Fed, what can't be taken seriously is Fisher's presumption to know that now, as opposed to one year or six years ago, is the time to "dilute the punch." We would properly mock such an exhibition of hubris from a FCC Commissioner about the availability of smartphones, but we embrace it when it comes from an official at the Fed?
The obvious truth is that no one, and no collection of persons, can know how much or how little credit there should be. That is so because the Fed doesn't create credit; rather it allocates credit taken from us first. Credit is created in the private economy, and amounts to one's ability to access resources created by the economy now, in return for future access to the economy's resources. The Fed can't presume to know how much or how little credit is or should be on offer simply because the Fed has nothing to do with its creation.
What the Fed can do, or better yet a U.S. Treasury empowered by the Constitution can do, is issue a dollar that is stable in value. The Fed or Treasury once again can't create credit, nor can they set the cost of it, but they can issue money that facilitates the exchange of present resources in return for access to future resources. Wise minds can debate the good or bad of the Treasury or Fed issuing money, but if done with stability of value in mind, it's pretty simple in the way that a foot or minute are simple.
Money is, or should be, a measure. Historically, gold has been the definer of the measure because it's so traditionally stable. Were money stable, credit would logically be most abundant simply because the offer of near-term access to the economy's resources would be guaranteed by similar access plus interest to future economic resources.
At present, economists all over the ideological spectrum, along with hawks and doves inside the Fed, accept the status quo whereby the Fed presumes to decide how credit will be allocated through its funds rate. Of course to the mildly sentient among us, Fed actions are - like any other form of central planning - going to foster varying degrees of credit scarcity by virtue of them depriving the economy of real price signals that ensure availability of what is desired. This explains why the Fed surely can't improve our economy, but depending on how much it limits its actions, it can do less damage than normal such that the economy grows more than normal.
And that's why Janet Yellen will likely have a successful Fed tenure. Thanks to the impressive failings of her predecessor in Ben Bernanke, failings that included the hubristic imposition of "quantitative easing," Yellen will not have near the power that Bernanke did. Because she won't, her ability to impose major damage on us will be limited. Instead, the failings of QE mean Yellen gets to at least partially undo Bernanke's mistakes with "tapering."
Yellen's economic genius won't win her a successful stint at our central bank; rather her inability to impose the silly ideas that populate her mind will make her time at the Fed successful. In short, Janet Yellen's ability to follow her natural instincts will be limited, and those limits are the key to any success that is always and everywhere a function of what Fed officials do not do, or aren't allowed to do.
