Oh for the days of yesteryear, when everyone believed Alan Greenspan was the master of the universe. Sitting in his high-backed leather chair, surrounded by the million levers of the machine called monetary policy, he could steer the domestic and international economy with precision. His every word, every breath, caused markets and currencies to rise and fall. Surely without him and his legendary intellectual power all would be lost.
You know what? It was all hooey. The Fed chairman has only one power: to create or destroy money. Even that power is limited by the behavior of the markets themselves. If the demand for money and loans isn't there, cutting the federal funds rate doesn't do the trick. He can buy and sell government bonds, but that is dangerous business because too many bonds purchased in the open market can cause the dollar to fall and price inflation to rise.
In the end, Greenspan has lots of power to create havoc, and very little to do good. In fact, the best path he can take toward doing good is to do nothing, which is very much against his grain. We learned that during the Mexico crisis, and again during the Asian crisis. We have learned that yet again — hoo boy have we learned — during the weeks that followed the September 11 attacks.
Just look at the numbers, using the broad measure of money employed by the St. Louis Fed (MZM, or money of zero maturity). Before the attack, money was soaring at 10 percent growth annualized. After, it spiked to 15 percent and above (we'll know more when all the data have been accumulated). We may look at back at the end of the year and see money creation closer to 20 percent. And is there anyone that the Fed hasn't promised to bail out?
Many of us worried that the US would someday go the way of Japan, toward permanent recession combined with a central bank just begging people to borrow. The Japanese central bank recently lowered its rates again from 0.15 to 0.1, and not a soul believes it will do a thing to spur productivity. Knowing from history that history teaches central bankers nothing, many people knew that there but for the grace of God would go Greenspan.
And Greenspan has gone that way. Rates are now down to 2.5 percent. 2.5 percent! That's the lowest in 40 years. Real savings are nil. What people thought were savings — stock accounts — are losing value by the day.
Still, some people ask: why does Greenspan keep rates so high? Why indeed? Why not bring them down to Japan-style levels of 0.1 percent? In fact, why not abolish interest altogether and reinstitute the vision of assorted lunatics who believed interest to be immoral "usury"?
Here's why. Please memorize this answer: Printing money does not create prosperity. In fact, it doesn't produce any net social benefit. It only redistributes wealth, making each individual unit worth less and less and rewarding only those who receive the newly created money before the purchasing power of everyone else's goes down. Interest rates are the price we pay for living in a world of scarcity.
If you think about it, it's a nutty idea that printing money can create prosperity. If that's all there was to it, all issues in economics would have long ago been rendered irrelevant. Society would have been wealthy and productive for the last 3,000 years. But long ago, someone caught on that alchemy is nothing but black magic, and that counterfeiting — even when done by the government — is actually a crime, not a social service.
Tell that to the Fed, which still doesn't seem to understand that productivity is a consequence of saving (a word so rarely used that it probably won't appear in the next Webster's) and investment (real investment, not IPO manias). It requires sacrifice of present consumption and entrepreneurship on the free market.
But isn't new money essential at a time when the economy is weak? Quite the opposite. The reason the economy is weak is due to the preceding economic boom, which was all out of proportion to its fundamental justification in savings. The madness of the late 1990s was itself a result of monetary pumping by the Federal Reserve. The thing to do is allow the correction to occur so we can be on a solid footing for the future.
But the Fed has become so convinced that it is the Magical Prosperity Machine that it refused to let the recession happen. Once on that course, nothing could deter these people and their printing presses. Even a terror attack that destroyed the World Trade Towers wasn't enough to bring these people back to reality. It only provided another rationale for doing what they already wanted to do, which was flood the economy with money.
One analyst said: "The Fed can almost do no wrong by lowering short term interest rates now." Think again. It can forestall recovery by putting off an inevitable recession. It can chip away at the purchasing power of money. It can reduce the value of the dollar internationally. It can prop up businesses that should fail. It can spur investments that shouldn't exist. It can promote borrowing that no one can afford, setting people and whole sectors up for bankruptcy. It can even create hyperinflation. In short, it can ruin the economy and all those who work in it.
Not bad for two weeks' work. As Mel Brooks might say, it's good to be the Fed.
October 5, 2001
Copyright © 2001 LewRockwell.com