Bernanke Policies Will Be Stop-and-Go

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When President
Bush nominated Ben Bernanke to be the next chairman of the Federal
Reserve Board, the financial markets heaved a collective sigh of
relief. Bernanke, currently chairman of the Council of Economic
Advisers after serving on the Fed’s board of governors for nearly
three years, is considered an outstanding economist.

admirers come from both sides of the aisle in the U.S. Senate, which
must vote on his confirmation. Republican Richard Shelby of Alabama,
who chairs the Senate Banking Committee, said, “Dr. Bernanke is
an eminently qualified and superb choice for the nomination of Federal
Reserve Chairman. He is extremely well-versed in monetary policy
issues and has earned tremendous respect and confidence from policymakers
in this country and around the world.”

Concurred Democrat
Charles Schumer of New York, “We need a careful, nonideological
person who understands that the Federal Reserve’s main job is to
fight inflation, and Ben Bernanke seems to fit that bill.”

When Bush picked
Bernanke on October 24, the nominee said, “If I am confirmed to
his position, my first priority will be to maintain continuity with
the policies and policy strategies established during the [Alan]
Greenspan years. I’ll do everything in my power, in collaboration
with my Fed colleagues, to help ensure the continued prosperity
and stability of the American economy.”

How good a
job will Bernanke do as the next chairman of the country’s central
bank? First, a little history of the Federal Reserve. It was created
in 1913 to provide the economy with an elastic currency to mitigate
the banking panics that occurred periodically throughout American
history, and to smooth out the business cycle and maintain the purchasing
power of the dollar. As a Progressive Era reform, the Fed was also
supposed to rein in America’s powerful banking sector. In reality,
the push for a central bank was a calculated public relations campaign
waged by the Wall Street banks that dominated America’s financial

The major Wall
Street bankers, from J.P. Morgan to the Rockefellers, saw the Fed
as their ticket to keeping interest rates artificially low and boosting
their incomes from loans. In addition, the Fed became the so-called
lender of last resort with the power to bail out the banks if a
liquidity crisis threatened a run on their deposits.

The Fed’s record
has been abysmal. Under the Fed’s sway the dollar has lost more
than 95% of its purchasing power, and easy-money policies spurred
the Roaring Twenties boom that led to the Depression. The boom-bust
cycle continued after World War II as the central bank has persisted
in manipulating interest rates. Whenever price inflation accelerates
because of the Fed’s cheap money policy, it tightens credit conditions
and ushers in a correction – i.e., a recession – or worse.

Despite the
Fed’s destructive policies, the American economy has shown remarkable
resilience. Productivity, output and employment have all increased
substantially since 1913. But in every Fed-induced boom some economic
sectors are pumped up more than others, and crash in the subsequent
correction. The late-1990s dot-com bubble provides the latest example
of the diversion of capital to an unsustainable boom.

The current
spike in housing prices reflects the Fed’s low interest rate policy
from 2001 through 2004. Will housing prices crash? While no one
really knows, the housing market is hardly immune from the old adage,
“What goes up must come down.”

So how will
Bernanke do as Fed chairman? He will perpetuate the myth that creating
money out of thin air is good for the economy. In short, after the
Fed stops raising interest rates early next year, Bernanke will
flood the financial system with money to stimulate the economy.
So hold on to your hats, it’s going to be a bumpy ride.

7, 2005

Sabrin, Ph.D. [send him mail],
is professor of finance in the School of Administration of Business,
Ramapo College of New Jersey, where he is executive director of
the Center
for Business and Public Policy.
Reprinted with the permission

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