An Economy Reliant on Janet Yellen Surely Isn't Worth Saving
Last week the Federal Reserve postponed any increase in the target interest (Fed funds) rate at which member banks lend to one another until at least December. Fed Chairman Janet Yellen's vague reasoning for her decision included a line about how the Fed is "struggling with a difficult set of issues."
Ok, if we ignore for a moment the truly obnoxious conceit on the part of central bankers that has them believing they can centrally plan economic growth, shouldn't we in the real world be a bit more skeptical? Centrally planned economic growth was tried in the 20th century with tragic, bloody results.
After that, a small amount of sixth grade level common sense is in order. Contrary to what we're told by economists, clueless financial reporters, and central bankers themselves, the Fed cannot ease, nor can it increase or shrink credit. Credit is what we create in the actual economy. When we seek credit we seek access to real economic resources such as trucks, tractors, computers, desks, chairs, and most of all, labor. These market goods are always and everywhere created in the private sector. The Fed has no private stash to release into the economy, nor can it withhold the resources created in the private sector from us.
So when the Fed raises or cuts the Fed funds rate, it is decidedly not adding or subtracting from the pool of available credit. At best the Fed, when it fiddles with the interbank lending rate, is distorting where already existing credit migrates to.
How much credit the Fed can force the misallocation of plainly isn't that great. We know this because the U.S. economy is, even in its slightly subdued state, still the richest in the world. If the Fed were truly powerful, and if it truly influenced the direction of a lot of credit, the U.S. would be poor.
In my latest book, Who Needs the Fed?, I feature impoverished Baltimore alongside superrich Silicon Valley to show readers just how limited the Fed's power is. Contrary to what we read in the financial press, and in economics books written by academics untouched by the real world, credit is never "easy." Little of it can be mis-directed by the Fed's central planners toward the impoverished (Baltimore), and just the same, little to none can be directed away from the productive (Silicon Valley) by those same planners. We needlessly flatter the Fed with our attention. Its power to do much of anything is very limited. When Donald Trump says that the Fed and its low rates are what prop up the economy and the stock market, he's merely revealing his own internal confusion about basic economics.
To see why this is so, readers need only consider the channel through which the Fed presumes to influence the U.S. economy: it's a banking system that is shrinking before our eyes as a source of credit. As of today U.S. banks account for 15 percent of total U.S. lending, but that number is in rapid decline as much more innovative, efficient, and skillful sources of credit eclipse our anachronistic banks. If the Fed were powerful, banks wouldn't be so weak. The banks are yesterday, and so by extension is the Fed.
Despite this, we hear all the time about the economic crack-up that awaits us not if the Fed "tightens" (it can't), but if it raises the target rate at which it would like banks to lend to one another. Supposedly slightly higher lending rates will have a contagious effect on the overall economy. This isn't serious thinking. Most lending in the U.S. economy has little to with banks or with a low Fed funds rate. Most businesses pay much more for access to credit. Referring once again to dynamic Silicon Valley, credit is so expensive there that resource-seeking founders of start-ups have to first give up a big portion of their business to a venture capitalist in return for funding, and then even more in the form of stock options to lure quality workers into their employ. Rates of interest among stodgy banks that the Fed tries to influence aren't a factor in dynamic finance.
In fact, the vast majority of businesses in the U.S. don't rate much bank attention as is. Michael Milken earned a fortune based on the previous truth. There's a high-yield market, there's venture capital, and there's private equity (to name but three of countless sources of finance) precisely because careful, deposit-taking banks aren't - and can't be - much of a factor in most allocations of credit. Only one new banking company has incorporated since 2010, which is further evidence that dynamic, profitable finance is taking place well away from banks. That being the case, why on earth would serious people shower any kind of attention on how the Fed interacts with what is dying? Soon enough we'll view the businesses that actively seek out banks for finance in much the same way that we might cast a quizzical eye at a movie buff who still watches films on VHS cassettes.
Others will say the Fed's machinations have propped up the stock market, and that's why they're necessary. So while the presumption that the Fed's interactions with superannuated banks could be tricking stock markets into rally mode defies simple common sense, let's assume for a moment that what is absurd is in fact true. If the Fed's interactions with banks have truly stimulated a stock market boom, that's precisely why we should be clamoring for the Fed to cease all attempts to influence anything in the economy. Indeed, if what is absurd is true (why can the Fed plan stock market rallies that no other global central has proven capable of?) about the Fed having created a rally, then it's also true that the Fed has propped up a market to the economy and stock market's overall ill-health. We know this simply because markets exist to relentlessly push resources to their highest use by starving the laggards first.
In that case, if it's true as Trump and other confused pundits believe about the Fed being the source of the market rally, that tells us that the Fed has needlessly kept precious resources in the clutches of weak companies to the detriment of their much more capable replacements. Explained in very basic fashion, if Fed interventions have fostered an artificial rally, that means a collection of formerly important Blackberry-style companies have been propped up at the expense of their Apple-style replacements. Assuming what is unlikely, that the Fed's rate stance has created an artificially growing economy and stock market, then by definition its actions have deprived us of a much greater natural economy and natural stock-market boom. This is basic economics. Economies only work if markets are constantly starving the bad in favor of the good.
Seemingly missed by both sides of the Fed debate is that while the Fed's power is vastly overstated, to the extent that its actions can influence the economy at all, we're all worse off. Central planning doesn't work. Ever. Applied to Janet Yellen, assuming her fiddling is aiding certain businesses or certain markets, then by definition they're not worth saving. If it's believed that the Fed is keeping the economy afloat even a bit, that's the surest sign of why the Fed must be required to relinquish its power as quickly as possible.