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.
Bernanke’s 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 sector.
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.
November 7, 2005