Plus, Should Ben Bernanke be brought back to the Fed?
First, Business Week one week ago had an issue with the cover story
Obama and Business, How Corporate America sees the President
Here is John Byrne, executive editor of the magazine, talking with the lead writer on the story, Jane Cecine.
After the financial sector sank the economy and the president followed the pro-Wall Street line of his Treasury Secretary, you would think business would be quiet. The regulation, higher taxes and growing intervention of government was required by the meltdown of the laissez-faire economy. Business takes no blame, however.
Where was the Business Week story about how Bushonomics sank the economy? Where is the mea culpa in corporate America? Very muted. More muted than their criticism of the president. You would think Business Week would go back and see how business has fared under Democrats and Republicans and discover who has been more beneficial to the bottom line, the stock price, or any other measure.
But no. The American Enterprise Institute and the Heritage Foundation have made their business to convince any and all that big government is bad for business. It is not a debate over policy or strategy, it is a propaganda war.
Business Week, Idiot of the Week.
Bernanke back at the Fed
The question of the day, or one of the questions, is whether to re-up Baffled Ben Bernanke in January for another term as head of the Federal Reserve.
You know our response: Bernanke failed to understand the crisis approaching, allowed the systemic collapse to unfold until at the last moment he rushed in with trillions in central bank funds for the big banks, and now clings to the tatters of his legitimacy with the plaint, "At least we avoided the Great Depression."
It's a defense that is far less justified but far more accepted than the similar one from the Obama Administration. In spite of the clear positive effects of the Recovery Act (see ChristinaRomer's defense to the National Press Club posted on the blog), Obama is not getting much traction with "It could have been worse."
But for Bernanke it works, we suspect because Ben is playing for the powerful financial interests, and so long as he protects and enriches them, no damage to the real economy is big enough for them to ask for a replacement.
At this point it is difficult to see what strategy Ben has promoted that has actually worked. Outside the big banks, I mean.
His early protests, if you will recall, were that a "complex series of causalities" (I believe that is a quote) had created the securitization problem which had blown up in the banks back rooms and smoked out the front offices. It was necessary to refloat the market with cheap interest so thesecurities would regain value. Didn't happen. House prices dropped like a stone. The shady securities based on shaky mortgages dropped even faster.
The complex series of causalities was a housing bubble inflated by cheap money from the Fed and securitization practices that created theCDOs and other, even more far-fetched ways for people to pretend they were getting high yield with low risk. This kind of alchemy did not turn lead into gold, but only painted it for the benefit of gullible investors around the world.
After this plan to reflate housing prices came a cropper, Ben moved in to replace the credit mechanisms that froze up in the cold of bank insolvency. These did not do the job either. Credit did not get back into the economy, but banks got cheap chips to run their market games.
The Fed has fed the banks directly through the bailout of AIG and by accepting garbage in exchange for full faith and credit. Of course we're not supposed to know it's garbage. Bernanke has done everything to conceal what was taken as collateral. It is very probable that the balance sheet of the nation's central bank looks very much like the balance sheet of the biggest zombie banks. We wonder how much the Fed stands to lose if Citigroup, for example, goes under.
It is no exaggeration to say that everything that could be done has been done to save the architects and conspirators of the current economic calamity and very little has been done to help the victims. We would have to include the Fed among the conspirators, because without their cheap money and their purposeful avoidance of oversight, thecurrent calamity could not have occurred.
This save the banks strategy is an extension of the academic work of Ben Bernanke, which was centered on an explanation of the Great Depression as being caused and continued by the failure of the banking institutions. This was an extension of the equally fallacious theory of Milton Friedman that the FederalReserve's monetary policy was the sole cause.
The economists of the time -- Keynes in particular, but those of the New Deal as well -- worked out the actual causes as a dearth of aggregate demand and the failure of the financial sector. They devised solutions, including the creation of the SEC and the Glass-Steagall restrictions on banks and so on. No matter how successful in practice and for the following half century, these remedies were not up to the exacting standards of the hypothetical worlds of academic Monetarists.
In any event, Bernanke's theory followed from Friedman, but added to it the bit about if the banks were allowed to fail, credit and lending would dry up and the economy would tank. We now see that the banks were saved at tremendous cost, but there was no creation of credit for the real economy and lending dried up anyway. To repeat, saving the banks did not generate lending and investment, but only transferred wealth from the taxpayer to the banks.
The remedy that is required is a change in incomes and jobs, a demand side remedy, one that will not be forthcoming from the private consumer economy this time around, but which needs to be supported by the consumer and accommodated by the Fed.
We have to interject the observation that the tremendous costs of zero percent lending to the banks created far less demand for automobiles than the cash for clunkers direct subsidies to consumers.
So, rather than embracing the mechanisms of the New Deal that did work, Bernanke has set out on the Monetarist's preferred path. But before we follow him,
What are those New Deal mechanisms?
- The closing of insolvent banks.
- Restrictions on the size of banks
- Restrictions on the range of financial activities that could be undertaken by a single institution, famously the separation of consumer banking and investment banking.
- The Home Owner's Loan Corporation, which shared the write-down of principle between borrower and lender.
Ben Bernanke is a bit like Bill Bavasi. Bavasi was brought in to take the baseball team in my home town to the next level. He applied his philosophy of power at the corners and big innings to a game where pitching and defense is the winning philosophy. Not surprisingly, the team tanked. Bavasi was replaced with a pitching and defense guy. The team recovered.
So Ben in applying the Monetarist plan applies something that has not worked and will not work. It is not an absence of a philosophy, nor an absence of aggressiveness in pursuing that philosophy, it is the limitations of the philosophy itself.
Let us compare. After the Second World War an enormous pent-up demand from consumers who had built up savings during the war met a severely restricted supply as business and industry tooled to war-time production scrambled to generate peace-time products. Combined with this, particularly agricultural products were desperately needed in Europe and elsewhere. The result: an enormous demand-pull inflation and an insistence by the conservative Republicans and banking leaders that interest rates be employed to dampen the demand. The Truman administration instead adopted a policy of building out of the inflation. Rather than reduce demand, they chose to increase supply, to put it simplistically. The inflation did not morph into the recession as it had after the First World War.
Compare that with the cost-push inflation of the 1970s. The Federal Reserve under Paul Volcker administered the Monetarist prescription, restricting the growth of the money supply. Interest rates skyrocketed, including on government debt. The country went into the double-dip recession that was arguably the most severe downturn between the Depression and now. Out of it came the Latin American debt crisis and the S&L debacle. But prices eventually went down. Along with real incomes. This quote victory unquote for Monetarists remained the model for the next thirty years. Signs of inflation were stomped on by higher interest rates and the resulting recessions were accepted as a necessary side effect of the medicine. Incomes continued to stagnate. Interest rates were substituted for restrictions to the money supply, because control of the money supply was once and for all lost as a tool with the advent of credit cards.
Now we are presented with a Federal Reserve Chairman who was once sure to ride to the rescue of a failing economy and now is characterized to have done everything he could with a limited tool kit. What he has done is make the banks profitable and leave them as long-term drags on the society. He has not restarted credit and lending. Asset prices did not recover. The toxic securities question has not been resolved, and they continue on the balance sheets at values higher than they are ever going to bring in.
The problem is not only with Ben, but is systemic. One finding of the New Deal was that the banks had too great control of the central bank. Each of the regional Federal Reserve Banks is literally owned by the private commercial banks in its region. This was thought to have led to some of the bad actions by the Fed during the 20's and 30's. So seven seats were added to the Fed's board, and the number of Regional Bank presidents who could vote was reduced to five. Simultaneously and increasingly through the War years, the Treasury and Administration directed central bank interest rate policy. This meant good things for the cost of financing the war debt, and kept debt service costs low for everyone.
This arrangement was dissolved in 1951 during the darkest days of the Korean War, when Truman's approval ratings were in the "W" range, with his Treasury Secretary in the hospital and negotiations conducted by a deputy named WilliamMcChesney Martin. A deal was struck which to this day is the root of the Fed's independence as the fourth branch of government. The so-called Treasury Accord gave the Fed its role as sole architect of monetary policy. WilliamMcChesney Martin appeared as Fed chairman soon after.
This is, of course, not the history that has come down to us, because the victor's write the history.
We note with some alarm that the recent actions by Bernanke's Fed in granting huge loans and bailouts to specific companies is a direct step into fiscal policy for the Fed. Though we are happy that the idea that the Treasury take on these debts from the Fed has apparently died its deserved death.
In any event, the banking industry controlled the central bank leading into the Great Depression and it regained control of the Fed subsequent to World War II. The so-called independence of the Fed is really capture by this banking industry.
Any real recovery of economic policy will have to go through a reform of the way monetary policy is controlled by those who benefit from a one-sided policy, and that is recapture of the Fed from the banks. Will that happen? Likely not.
In case you were not quite clear on this point, Demand Side believes that reappointing Ben Bernanke is the absolute wrong thing to do. His personal and academic philosophy is one that is wrong, hasn't worked and needs to be rejected emphatically. A much closer tie between monetary and fiscal policy needs to be established in order to solve the current mess. The control of the central bank by the banks it is supposed to be regulating is essential. None of this will happen with Bernanke.
We made a hash of our reading of the benchmark revision tables from BEA last Saturday. One thing we have to note again is the effect of government spending. Not only is it half the positive contributions to GDP in the second quarter -- the other half being,problematically, net exports -- but $110 billion dollars of tax cuts went into the discretionary spending and presumably PCE, personal consumption expenditures.
With only government and the oil-induced net exports being positive, and PCE, nonresidential equipment and software, nonresidential structures, inventories and residential investment all negative, along with the continuing downward movement in employment, we feel -- and you should mark us down -- as among the more bearish on the economy.
The Economic Policy Institute has a piece out, to be put up maybe tomorrow on the blog, showing that even from the low levels of an extrapolation of the jobless recovery of Bush II, the economy is down nine million jobs. The question of Depression is still in the balance.