THE FEDERAL RESERVE is reportedly upset about the dollar's recent strength, fearing this will foil its desire to create a certain amount of inflation and thereby retard economic growth. In the Fed's mind a more muscular greenback will also hurt exports, which will be another growth dampener. The result, the central bank is muttering, may be the postponement of previously hinted-at increases in interest rates, starting in mid-2015.
The Fed's new fears are bad news, because acting on them will bring about that which Janet Yellen & Co. is purportedly worrying about: a weaker economy. It never occurs to the central bank that its actions after the 2008–09 panic have been the biggest barrier to a vigorous economic rebound.
Credit is critical for commerce, from financing inventories and purchases to expanding existing businesses and starting new ones. The depth and breadth of U.S. capital markets has been a huge advantage in our ability to nurture new companies and provide the lubrication for business' everyday needs. The Fed's unending schemes for "stimulating" the economy--from Operation Twist to all the variations on quantitative easing--have had the unintended consequences of seriously distorting and hindering the functioning of our credit markets and, hence, our economy's ability to expand.
Interest rates are the cost of credit. Suppressing these prices clogs the arteries of commerce. The federal government has had easy and cheap access to money (deficits without tears), as have most large companies. For other commercial enterprises, however, the situation has been a lot more difficult and uncertain. For example, the size of credit lines is reduced, the conditions under which money is loaned more stringent and personal guarantees far more frequently demanded.
Perversely, bank regulators still cast a gimlet eye over most loans to most nonbig businesses. "Strengthen your capital position" is an ongoing regulatory admonishment to banks, which has the effect of suppressing vibrant lending.
The Federal Reserve has sucked up vast amounts of cash to finance its purchases of long-term government bonds and mortgage-backed securities. The private sector has been hurt correspondingly.
The Fed publicly frets over the threat of deflation. But its actions are deflating the economy, not to mention commodity markets. Speculators long in gold and oil, take note.
Our central bank's obese balance sheet has blinded observers to the contractionary effects of the Fed's actions. Yes, bank reserves have proliferated faster than horny rabbits. But thanks to regulatory restraints and the pressure to load up on more capital, as well as the addictive nature of receiving interest on those excess reserves, a corresponding expansion in lending hasn't occurred. The growth in the M2 money-supply number has been anemic, a stunning contrast with the 1970s, when a bulge in reserves far smaller than today's led to an explosion in the cost of living. In those days the Fed bought only short-term Treasurys, regulatory barriers to lending were comparatively mild, and there was no across-the-board suppression of the price of credit.
The Federal Reserve did immense harm in the 1970s. It's doing so again now, albeit in a far different manner.
Astonishingly, then and now, criticism of the Fed is mostly muted. This ever more powerful and disruptive entity is the ultimate Teflon-coated institution.
(See Steve Forbes’ new book, Money: How the Destruction of the Dollar Threatens the Global Economy—And What We Can Do About It.)
