The Fed Isn't Helping Economic Growth
With calls for more "investment" from President Obama in his State of the Union Address, tax reform off the table in a divided Congress, and inefficient regulations discouraging investment, Federal Reserve Chairman Bernanke is left on his own propping up the economy with his generous monetary policy.
But his efforts may do more harm than good. If countries could print their way to prosperity, wed see many growing economies.
Bernanke has said that hell keep up the rock-bottom interest rates and bond purchases until the unemployment rate reaches 6.5%. At the current rate of 150,000 jobs created every month, and 110,000 new entrants to the labor force, that will be around January 2017.
The European Central Bank and the Bank of Japan are following Bernanke. The European Central Bank is trying to keep the euro, the 17-country common currency, from fragmenting and imploding. Japans Prime Minister Shinzo Abe is talking about reflation. Such currency wars will be the subject of discussion at the G-20 meetings this Friday in Moscow.
My colleague Rex Nutting says that the Fed is the only institution in Washington trying to restore full employment. Read why Rex Nutting and the CBO think big deficits are needed for the next four years.
Congress and the president should not count on the Fed to bail them out of their mistakes. Those who lobby the Fed to pump more dollars into the banking system (money the central bank lawfully creates) fail to recognize that borrowing costs are already at record lows, and that more liquidity is unlikely to impart more impetus to the sluggish recovery.
The Fed is charged by law with maintaining price stability. Fed hawks, chiefly presidents of the regional Federal Reserve banks, worry that more liquidity will sow the seeds of faster, future, inflation.
Interest rates have been on a roller coaster over the last decade. In 2002, the federal funds rate held steady at around 1.75%. After decreasing to about 1.0% in mid-2004, the federal funds rate climbed to a plateau of about 5.25% between the summers of 2006 and 2007. However, from the end of 2007 to the beginning of 2009, the rates declined to 0.2% and below, and have hovered there ever since.
A loose monetary policy raises the dollar price of commodities, harming the economy.
Take oil, for example.
John Tamny, editor of Forbes.com, has calculated that ever since the 1971, when America left the Bretton Woods system and ended the dollars link with gold, 15 barrels of oil have been worth an ounce of gold. As the value of the dollar declines, the price of gold and other commodities rises. (See gold and oil prices in table 1.)
Tamny told me, "In 1971, when gold was at $35 an ounce, an ounce bought 15 barrels at $2.30. In 1981 at $480, an ounce bought 15 barrels at $35. Two years ago an ounce at $1,176 bought 15 barrels at $79, and now an ounce buys 17 barrels. The latter number suggests oil will gradually inch its way back up. "
Commodities such as corn, wheat, and sugar also rise as the dollar declines and gold rises. (See gold and corn prices in table 2).
Higher prices for oil mean higher prices for gasoline. Higher prices for grain translate into higher prices for food. All these act as a tax, slowing the economy.
In addition to higher commodity prices, a weak dollar penalizes those who save and who live off of savings. Frugality is punished, and spending, especially on credit, is rewarded. The elderly who have saved money for retirement find that their nest eggs do not produce as much as income as anticipated. As inflation rises, as is has always done after monetary growth, the nest eggs shrink together with the value of the currency.
In 2010, the latest year available, over 90% of families in all age groups owned some types of financial assets, including checking accounts, CDs. Retirement accounts, stocks, bonds, pooled investment funds, and cash value life insurance plans.
Other than checking accounts, the largest category of financial assets is in savings accounts, as would be expected from their tax-preferred status. Almost 60% of families with heads of household between 45 and 65 own retirement accounts.
According to data from the Census Bureau, seniors ages 65 and over made an average of $3,154 from interest in 2011, and an average of $31,557 in total income. Thus on average, 10% of their income came from interest. A higher interest rate would have raised the income of seniors by thousands of dollars.
With the current interest rate at about 1%, at an interest rate of 2%, an average senior would have earned $6,300 annually, a difference of $3,000. At a rate of 4%, he would have earned another $9,500. At 6%, he would have earned $19,000 annually, $15,800 more than now. This is especially important because a substantial share of seniors income comes from interest-bearing investments.
Obamas proposals for caps on carbon, a higher minimum wage, and government-funded infrastructure wont cure the economy. Neither will the loose monetary policy pursued by the Fed, which discourages savings and raises commodity prices. Congress and the president cannot rely on Bernanke forever.
This piece originally appeared in WSJ's MarketWatch
This piece originally appeared in WSJ's MarketWatch