United Liberty

Once again, Bernanke is the object of my funny bone. The day is coming soon when his mettle will be tested.

Ben Bernanke is showing himself to be more of a Big-Government politician than a scientist. In his latest speech, he has tried to defend the actions of his predecessors by claiming that their easy-money monetary policy only holds five percent of the responsibility for the high real estate prices that ignited the boom-and-bust bubble that almost broke the back of the global economy.

According to his analysis, 30 percent of the responsibility goes to what he has been calling the “global savings glut.” The other 65 percent, he says, belongs to the inferior standards of the US mortgage market. Therefore, his argument seems to be saying that if we cure the standards we cure the problem.

He attempts to prove his point by demonstrating through charts that other countries had even looser monetary policy than the US, and yet they did not show a worse real estate boom; therefore, he concludes, loose monetary policy does not cause bubbles.

This sounds convincing, coming as it does from the highest-placed economic academician in the land. But his logic is flawed.

There are two problems with his argument. First, you cannot isolate these particular variables as he has done. To do so is the equivalent of saying Michael Phelps eats a lot, and he is not obese, therefore a high-calorie diet does not cause obesity. (Michael Phelps is the Olympic medalist swimmer who purportedly eats around 8,000-10,000 calories a day. A scientist could probably prove that he also spends almost 8,000-10,000 calories a day in his sports activities.)

Bret Stephens has written a nice opinion piece in the Wall Street Journal of December 23. He cites poet Rudyard Kipling and author George Melloan who wrote The Great Money Binge: Spending Our Way to Socialism.

Melloan’s work, according to Stephens, shows “in exacting detail, not only how we came to our current crisis—thank you, Barney Frank, Chris Dodd, Alan Greenspan and Tom DeLay—but where [their flawed logic] is destined to take us again.”

All four of these politicians—yes, Greenspan is one of them—seem to subscribe to Keynes’s theory of what some have called “demand-side economics.” This theory says that consumption is the answer to an economic bust cycle, and that it’s okay to create the credit to pay for it through central-bank-created funny-money.

Stephens, citing Melloan I presume, and parodying Kipling, counters Keynes’s theory using the supply-siders’ argument:

”’[C]onsumption must be paid for with production” … if you don’t work (i.e. produce) you die (i.e., can’t consume).”

Stephens and Melloan have understood the evils of Keynesian spending-for-prosperity, to be sure; but they have missed an essential point, which is this:

Consumption is purely a mechanism by which producers share among each other what they have already produced.

(See this post and the subsequent two posts for a more detailed example of this process.)

In a most insightful commentary published in the Financial Times of last Wednesday, Martin Taylor, himself a former banker, quipped:

“All business people know that you can carry on for a while if you make no profits, but that if you run out of cash you are toast. Bankers, as providers of cash to others, understand this well. They just do not believe it applies to their own business.”

The reason bankers have trouble judging their own cash flow, he writes, is that “[i]n general, banks have no measures of cash flow that work for banking.” He describes (with a great sense of humor) how bankers got us into this Great Recession by paying out “colossal accounting profits” in cash that were “largely imaginary…. Not only has the industry—and by extension societies that depend on it—been spending money that is no longer there, it has been giving away money that it only imagined it had in the first place. Worse, it seems to want to do it all again.” (He’s referring to the banking bonuses, which are at a new high.)

He ends the piece perfectly:

“How depressing the shame and folly of it all is, when one considers that the system was brought down not because risk management was deficient (though it was), nor because greed was rampant (though it was), but because bankers could not count. Merry Christmas.”

This really states it all in one newspaper column.

Last week, two experts on the Treasury and the Fed gave a very interesting talk about the two entities’ balance sheets. This is especially timely as the President is talking about applying the “leftover” TARP money to a new stimulus venture, and the Treasury is about to vote federal employees an unconscionable pay raise.

This conference was sponsored by the Cleveland-Marshall Libertarians and the Cleveland-Marshall Federalist Society and was called “U.S. Monetary and Fiscal Policy: Going Exponential.”

Just to give you a taste, the following are excerpts from a good review by Kevin Lovach, the Co-Editor in Chief of The Gavel, CSU Ohio:

“[Walker] Todd is a former C-M professor who served as an officer of the Federal Reserve Banks of Cleveland and New York. He joined Case Western Reserve University Professor Emeritus William Pierce in analyzing the Federal Reserve’s monetary policies and federal deficit spending. Pierce served previously as Chair of the Case Economics Department.

“Stressing his view that the problems stem from Washington, D.C. and the banking-heavy northeast, Todd said ‘the existing Federal Reserve leadership needs to be booted out.’ He quipped, ‘I’d like to see the Board of Governors hanged first, the New York Fed hanged second, Boston hanged third.’

“Pierce put federal deficit spending for the 2009 fiscal year at 9.9-percent, a figure topped only by spending during and immediately after World War II. He argued that while the economy can handle deficits of three-percent of gross domestic product ‘forever,’ anything substantially higher ‘becomes real money.’”

In the latest Buttonwood post at the Economist entitled “Paper promises, golden hordes,” the writer notes that gold is coming back into vogue. The price has tripled over the last six years, says another researcher, David Ranson of Wainwright Economics.

It looks like the public has decided that paper money isn’t so attractive at this conjuncture, and even some central banks are thinking along those lines, to wit Russia, China, and India.

All this makes perfect sense. Gold is not only a store of value; it’s a barometer for currencies.

This flies in the face of a recent paper by Barry Eichengreen and Douglas Irwin, cited in the Buttonwood post. These two economists have come to the conclusion that “[d]ropping gold did work” i.e. that abandoning the gold standard has somehow shortened recessions and reduced the inclination to raise as many tariffs.

Other economists would disagree. They hold that, in fact, dropping the gold standard and instituting a process of monetary expansion through a central bank is what caused the distortions in the economy in the first place, which in turn led to the recessions and even the Great Depression itself.