Economic Outlook: More Darkening Clouds


Every American, from the top Fortune 500 CEO to the youthful fast-food hamburger flipper, owes his standard of living — the highest in the world — to free market capitalism. It’s capitalism — private property and free markets — that provides the information and the incentive that allows each of us to maximize the value of our economic activity. Yet to hear the (mostly) Democratic presidential candidates tell it, free markets are faulty, unfair, and inherently unstable; indeed, government should constantly regulate markets and ride to the rescue whenever recession threatens.

The overall economic ignorance displayed in this year’s political campaign has been staggering. Instead of calling for balanced budgets, sound money, permanent tax reductions, and less regulation, most of the candidates have called for more inflation and more government intervention.

Hillary Clinton, for example, has said that she personally intends to “manage the economy” not understanding, apparently, that the “economy” is simply a metaphor for the billions of individual decisions made every day that no one person could ever “manage." Recently, all of the Democratic candidates and several of the Republican candidates (and President Bush) have advocated various economic “stimulus” programs (including rebate checks in the mail) not understanding, apparently, that any one-time spending shot (with borrowed money) will fix precisely nothing. (Lower individual and corporate tax rates would be helpful, however.) And finally, several of the candidates want a short-run government moratorium on millions of impending mortgage foreclosures not understanding, apparently, that breaching contractual agreements and postponing the economically inevitable is not necessarily a smart thing.

The most significant area of economic ignorance, of course, is with respect to the Federal Reserve policy. All of the candidates, both Democratic and Republican (excepting Congressman Ron Paul) have applauded the Central Bank’s recent decision to dramatically lower the federal funds target rate to 3.5%; it may even be pushed lower. (The federal funds rate is the rate at which banks lend to other banks). To accomplish this reduction will require massive purchases of government securities by the Federal Reserve Open Market Committee which, in turn, will make mountains of new liquidity available to potential individual and institutional borrowers both here and abroad. .

Now this is a good thing, right? WRONG.

During deep recession with high unemployment and significant idle industrial capacity, some economists (not me) would advocate an aggressive “easy money” policy to jump-start the economy. Be that as it may, that is emphatically NOT the current situation. Additional liquidity from the Federal Reserve now would only serve to prop up tottering malinvestments (mostly in housing and finance) that are themselves the creature of the last Federal Reserve money bubble. Further, additional liquidity will give rise (at the margin) to additional malinvestments that themselves will never be successfully completed due to a dearth of real savings. Were all of the candidates asleep during the “business cycle” lecture in Economics 101?

Further, any new aggressive easy money policy will only further weaken the value of the dollar and eventually lead to more price inflation. In my last op/ed (“Darkening Clouds”) I predicted that the Fed dare not push interest rates much lower since it risked destroying the dollar — the world’s reserve currency — and dollar investments both at home and abroad. Well, I obviously underestimated the recklessness of Federal Reserve Chairman Ben Bernanke and the rest of the gang on the Open Market Committee. To save Wall Street speculators and influential financial institutions (that took absurd risks), the Fed now appears willing to drive the real rate of interest (rates adjusted for inflation) to near zero. Now if that doesn’t deepen and aggravate all of the on-going economic distortions already in place, I don’t know what will.

In conventional terms, the only thing worse than a recession in the U.S. would be world-wide INFLATIONARY recession. Well, the Federal Reserve and the Bush Administration have now set us up for exactly that dismal scenario. As Betty Davis growled in All About Eve: “Fasten your seat belts; it’s going to be a bumpy ride."