The Federal Reserve’s Bubble Thinking
Federal Reserve Chairman Janet Yellen delivered her semi-annual monetary policy testimony to Congress last week. While she walked back some of her previous comments that another financial crisis wouldn’t occur within our lifetimes, her testimony and her answer to questions made it clear that the Federal Reserve doesn’t really know what’s going on with the economy. Caught up in their own little bubble, the folks at the Fed are completely unaware of what’s happening outside the Beltway.
Federal Reserve Transparency
One of Yellen’s testiest exchanges was with my former colleague, Congressman Bill Posey, who asked her about my old bill, the Federal Reserve Transparency Act, also known as Audit the Fed. The bill has been reintroduced this Congress but the Fed continues to oppose it, just as it opposes any attempts by Congress to establish greater transparency of the Federal Reserve’s workings.
Yellen seems to think that auditing the Federal Reserve’s conduct of monetary policy would destroy the Fed’s “independence.” Independence from what? The Fed was created by Congress and the Chairman and the Board of Governors are appointed by the President and confirmed by the Senate. The Fed isn’t a fourth branch of government, its job is to pursue the monetary policy that Congress has directed it to, and to remain accountable to Congress for its conduct.
Yet the Fed time and time again tries to shirk its duties. Every effort to gain greater insight into what the Fed is doing is stonewalled. It’s unconscionable that Congress continues to allow the Fed to escape the same oversight that other federal agencies receive.
Clueless on the Economy
Yellen’s testimony also underscored that the Fed doesn’t really know what’s going on in the economy. What’s happening today is a repeat of the 1920s, with the Fed clueless as to what is going on. Remember that in the 1920s the price level remained stable, that is, price inflation was near zero, despite the fact that the economy was booming.
That’s because the increase in production should have led to falling prices. But because the Fed was pumping money into the financial system, prices remained at the same level. It wasn’t until the Fed stopped the money printing that all the malinvestments caused by its loose monetary policy were revealed. Stock market crashes and bank failures ensued, resulting in the Great Depression.
The Fed today continues to look at the price level, targeting a price inflation rise of 2 percent per year. Yellen and company have been frustrated that price inflation has consistently been under 2 percent, and they intend to keep the Fed’s accommodative monetary policy in place until that 2 percent target has been reached or even exceeded.
What the Fed isn’t seeing is the reason why price inflation is so low. The bad debts and malinvestments that were brought to light during the financial crisis were never liquidated and put to better use. They’re still there, and market forces really want to see those bad assets marked down to their market value. Yet the Fed continues to pump money into the financial system to keep those asset prices elevated. Market forces are pulling one way while the Fed is pulling the other way. Eventually one of them will have to give.
Most likely it will be the Fed, which can’t continue printing money forever. Once it stops or significantly slows its accommodative monetary policy, the malinvested resources will come to light and the bubble will burst. We’ll see a return to the days of the financial crisis, only worse because the latest bubble will be so much bigger than the last bubble. Those who haven’t anticipated the bubble collapsing will end up being badly hurt. Those who have protected themselves by hedging their assets with gold and silver will be in much better position to ride out the rough waves that lie ahead.