Case Study: Misbegotten Federal Intervention

Posted by Guest Writer on March 26, 2012 under Why | Be the First to Comment

By Thomas Brewton

The Fed’s near-zero short-term interest rate policy distorts the market, with many ill effects and none of its proclaimed benefits.

In a speech today before the spring conference of the National Association for Business Economics, Federal Reserve Commissar Ben Bernanke, now an Obama re-election campaign mouthpiece, reaffirmed the Fed’s intention to continue imposing artificially low interest rates for short-term Treasury securities. According to the Washington Post’s report, he admitted that the economy and employment remain weak. But, he maintains, “the Federal Reserve’s existing policies will help boost economic growth.”

If that is true, one is entitled to ask why after nearly three years of this policy the economy remains in the doldrums. Unemployment, taking the most favorable measure used by the government, remains north of 8%. Using comprehensive measures from the government, measures that include people who have given up looking for jobs and have dropped out of the labor market, unemployment is running around 17%.

Nonetheless, the stock market again roared ahead today on Commissar Bernanke’s affirmation that the Fed will continue pumping excessive amounts of fiat money into the economy to keep interest rates low. Meanwhile businesses remain cautious about expanding, and consumer spending, as in the housing bubble that burst in 2007, is being floated on increasing debt and declining savings.

The Obama administration gets a free ride. If interest rates were not artificially depressed, the cost of funding our multi-trillion dollar deficits would soar when the Treasury markets new debt. There is also the ‘benefit’ of facilitating inflation to enable the Treasury to pay off today’s debt in the future with dollars worth less than the amounts of debt retired.

Liberal-progressives’ Keynesian macroeconomics deals with abstract categories, such as consumers, rather than with individuals in the real world. Keynesians expect to push policy buttons and get automatic responses from those abstract categories. If the government increases deficit spending on anything, consumers presumably will immediately begin spending more and unemployment will drop as business activity revives. That is why administration officials in 2009 promised, falsely as we have seen, that Obama’s first stimulus plan would keep unemployment lower that 8%.

The Austrian school of economics looks instead to incentives that produce myriad different responses from hundreds of millions of individuals, who do not in fact move like a herd of cattle directed by government prods. Austrians also emphasize that, even if government deficit spending should add to consumer spending, that does next to nothing to revive basic and intermediate industry such as housing construction, which constitute a huge portion of the economy. Companies making production equipment or producing basic raw materials will not increase production and hiring until costs and inventories up and down the line have been realigned. Theirs is a long term perspective, because of their much heavier investment of fixed capital. Consumer goods producers, in contrast, can quickly increase production of goods if demand increases and can as quickly shut down production lines when inventories build up.

What happens in the real world is that government stimulus spending and the Fed’s low interest rates benefit those groups who get the money first. People down the line, workers and producers of production goods and raw materials, see few beneficial effects.

First in line have been public service labor unions, which avoided the big layoffs experienced in the private sector. They also selfishly stymied almost all efforts to rein in their retirement and health benefits, which greatly exceed what real businesses pay and far exceed the capacity of Federal, state, and local governments to fund in the future.

Also at the head of the line were banks and brokerage firms. The economy remained flat on its back until recent months, but the stock market has enjoyed a huge gain since the dark days of 2007. Some of that was fueled by increased business profits, achieved mostly by cutting costs, including large layoffs of workers. Mostly, however, it was powered by abundant cheap money from the Fed.

Banks’ cost of funds is historically low, thanks to the Fed’s near-zero short-term interest policy. They can make a profitable spread over their cost of funds by purchasing medium to long-term Treasuries, without the risk and higher administrative costs of lending to individuals and businesses. This, of course, facilitates the Treasury’s rolling over trillions of dollars of Federal debt arising from deficit spending.

It’s obvious that the financial community was the first to bounce back when stimulus spending and low interest rates began, recording record profits and executive bonuses. Punitive Dodd-Frank regulations subsequently crimped earnings and bonuses, but the financial sector, the stock market in particular, continues to outperform basic industry.

Far down the line are individual savers, who have been hosed by the Fed’s distortions of interest rates. Income that can be earned on savings deposits, CDs, and other securities is less than the current rate of inflation.

Liberal-progressive state planners are happy with that. Keynesian economics, the theory followed by Commissar Bernanke’s Fed, identifies saving as anti-social and as the cause of business recessions. Far better to devalue people’s wages and savings via inflation and thereby to make them yet more dependent upon the government.

This post originally appeared in the View From 1776 blog.

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