Page 2 of 2 Bernanke still a speed demon By Hossein Askari and Noureddine Krichene
quality from his current cheap monetary policy. Such a dismissive attitude was
clearly expressed in the Federal Open Market Committee (FOMC) statement on June
24, 2009:
The prices of energy and other commodities have risen of
late. However, substantial resource slack is likely to dampen cost pressures,
and the Committee expects that inflation will remain subdued for some time.
Besides ignoring oil and food inflation that dealt a knock out blow to the US
and world economy in 2008, the FOCM statement was strikingly vague. It provided
no definition for "substantial resource slack". It considered money policy as
the panacea for all and did
not contemplate sectoral policies to address sectoral problems. If the US auto
industry suffers a slack of resources, an expansion of money policy will boost
Japanese car imports and will compound the slack of the US auto-industry. No
one knows how slack resources dampen cost pressure.
All we can infer from the FOMC statement is that a firm that is operating at
less than full capacity is "entitled" to buy crude oil at $20 a barrel instead
of the market price of $72 a barrel! Similarly, a food processor that is
operating at less than full capacity is entitled to buy corn, wheat, and
soybeans at 20% of the speculative market price and hire labor at less than the
minimum wage. In a nutshell, the FOMC rejects the notion of stagflation that
prevailed in the 1970s.
In his rebuttal to the original WSJ editorial of December 9, 2003, Bernanke
contended that "critics were not particularly well informed", as if critics
were living on a different planet. Recent events have shown that the public was
informed of the housing crisis, and the fact that millions of families have
become victims of it, loosing homes and becoming homeless. Unfortunately, it
was Bernanke who did not seem to understand how millions of foreclosures could
result from unparalleled monetary expansion. A simple answer is: a family with
four children and an income of $34,000 a year cannot afford a mortgage on a
house bought at $800,000 and a property tax bill of $10,000.
In more precise terms, housing speculation initiated by the Fed pushed housing
prices and property taxes to a level that was misaligned with household average
incomes and resulted in millions of foreclosures. Yet, in spite of such grave
misalignment, Bernanke is injecting $1.25 trillion in 2009 to inflate further
housing prices to still higher and unaffordable levels.
Besides bankrupting the Fed, his actions will only further compound the housing
crisis. Again, Bernanke sees money policy as a panacea for all and would
prevent any sectoral solution to the housing crisis, which has to be a downward
adjustment of property prices and taxes to realistic levels consistent with
household incomes, in spite of the invalid dilemma he has always raised that
such adjustment would reduce household wealth and therefore compress aggregate
demand.
Affordable mortgages and rent would enable household to increase their demand
for food, appliances, energy, and therefore increase aggregate demand. The
opposite would squeeze this demand. The income effect is more important than
the wealth effect. The housing problem is not credit availability as understood
by Bernanke; it is inability to service high mortgages and credit risk.
The attempt to boost home prices could turn out to be damaging for the overall
economy by flooding it with long-term liquidity, increasing household debt,
making housing unaffordable in terms of mortgages and property taxes, and
delaying economic recovery.
In June 2009, the US Treasury has issued a blueprint for revamping the US
financial regulatory framework. However, what sense does regulation make when
the Fed is inflating housing prices to foreclosure levels? No matter how
perfect regulation is, the continuation of such Fed policy will bankrupt the
Fed, households, banks and the state.
Under the influence of Bernanke, the FOMC statement reads:
Although
economic activity is likely to remain weak for a time, the Committee continues
to anticipate that policy actions to stabilize financial markets and
institutions, fiscal and monetary stimulus, and market forces will contribute
to a gradual resumption of sustainable economic growth in a context of price
stability.
Hence, Bernanke believes that zero interest rate
policy, money printing, and fiscal deficits at 13% of GDP will contribute to
sustainable economic growth. If these policies have brought the US and world
economy to a financial and economic crisis and pushed unemployment to 10%, what
black magic would now bring about sustainable recovery? Near-zero interest
rates and fiscal deficits have kept Japan in protracted stagnation for the
better part of 10 years.
As rightly projected by the WSJ editorial in 2003, the speed demons crashed the
US, which now suffers multiple injuries. Banks have been bankrupted and some
have disappeared. Fiscal deficits have soared under the weight of massive
bailouts and gigantic stimuli and are being monetized through money printing.
Government debt is rising without limit. Consumers are over-indebted and cannot
pay back their debt.
All in all, it would appear that reserve central banks have adopted the
position that zero-interest rates and money printing are all-purpose policies
and panaceas for all economic and financial disorders. The injection of
trillions of dollars by the ECB, the Fed, and other reserve central banks does
not inject a single barrel of oil or a bushel of corn into the economy. The
exercise is a pure de-basing of money, a redistribution of wealth in favor of
debtors away from creditors, workers, and fixed-income families.
Zero interest rates are purely distortive, fuel speculation, and destroy
savings and capital. Zero interest rates do not necessarily increase
investment. Firms rely heavily on their internal funds from profits or equity
shares for investment. Zero interest rates do not necessarily induce firms to
invest if firms predict no profits from expansion. US banks sit on $1 trillion
in excess reserves for which they find no safe or profitable use at zero
interest rates. The ultimate effect of unorthodox fiscal and money policy will
be a runaway inflation in the years ahead that will depress real activity.
Monetary stability in the 1980s and 1990s achieved durable growth and
employment. In this regard, former Fed chairman Paul Volcker remains a
legendary figure for his courage and ability to stabilize monetary policy and
afford the US a long period of money stability and growth. But the monetary
instability brought about by Bernanke since 2002 has led to chaos and curtailed
prosperity. The motto is: "Bernanke causes the mess, Bernanke fixes the mess.
The same people who made it wrong will get it right. We only have to be patient
and put our faith and destiny in their theories." But for how long must we
suffer?
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.
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