John on the economy

On Tuesday, Sept. 17, the Federal Reserve Open Market Committee’s (FOMC) 12 members will meet to determine U.S. monetary policy. That doesn’t mean much for those who don’t follow financial markets, nevertheless decisions made by the FOMC affect everyone in the nation. The FOMC decides how much cash the Federal Reserve (sometimes called “the Fed”) will put into or take out of the economy. For the uninitiated, that means deciding how much money the Fed will create out of thin air—also referred to as “printing money.” For next week’s meeting specifically, they will deliberate whether or not to keep printing $85 billion per month, as they have been doing for the past 12 months. I realized just how much influence the Federal Reserve has over financial markets after spending two years on Wall Street. Every single word uttered by Federal Reserve chairman Ben Bernanke is scrutinized. His tweets move markets. Since the Federal Reserve is so important to finance, I had to learn exactly how its actions influence markets and the motivations behind them.

The Fed’s $85 billion of monthly money printing is equivalent to a helicopter dumping about 30 tons of 100-dollar bills onto the streets every day. Printing money is a colloquial way of referring to FOMC bond purchases; the Fed controls the money supply by buying and selling bonds from big banks. You can imagine that injecting this much cash into the economy has a profound effect on financial markets.

Namely, it affects the interest rates on loans. Manipulating interest rates is how the Fed attempts to control the economy, and so money creation is really just how the Fed controls interest rates—which control the real economy. Hopefully that makes sense. It is a complicated process that takes years of schooling to fully understand.

If it takes years to merely understand how it works, imagine the knowledge required to decide how much money should actually be printed. Dozens of metrics are considered: the unemployment rate, new jobless claims, average weekly working hours, the S&P 500, manufacturers’ new orders for non-defense capital goods, and many others. With so many variables, it probably won’t surprise to hear that the Federal Reserve makes mistakes. Its decisions are always hotly contested no matter what they are, but only years of hindsight illuminate whether a decision was right or wrong.

You are most likely aware of the ‘08 crash and subsequent recession, and you are probably still feeling its effects. We all are. There were, of course, many factors that precipitated the crash, but one of the guiltiest culprits was actually the Federal Reserve itself. It all starts back with the 1987 stock market crash. “Black Monday” (10/19/87) saw stock markets plunge over 20 percent. In response, the Federal Reserve chairman at the time, Alan Greenspan, responded by printing money. Printing money lowered interest rates and spared investors even worse losses.

A pattern emerged throughout the ‘90s and ‘00s whereby the Federal Reserve would routinely print money following declines in the stock market to cushion losses. This policy set a dangerous precedent. In essence, financial markets believed that the Federal Reserve would step in to prop up them up whenever things got bad. A perpetual bail out. And since everyone would always be saved, it was thought, people began taking inordinate risks (prototypical example of a moral hazard).

In the early 2000s, interest rates were extremely low thanks to Greenspan’s printing-spree after the dot-com crash and Sept. 11. Cheap mortgages (along with lax lending standards) encouraged people to buy homes they couldn’t afford. Home prices started to rise. Then investors, starved of yield on account of low interest rates, turned to residential mortgage backed securities as a ‘risk-free’ way to make money.

Home prices continued to rise and everyone kept making money until the bubble burst, then everyone started losing money. And what did the Federal Reserve do? It went on the biggest money printing glut in history, of course. While its actions probably averted the worst, who knows what kind of Armageddon-type bubble five years of low interest rates have unknowingly begun to inflate.

Before we thank the Federal Reserve from saving us from complete meltdown in ‘08, let’s remember that it merely saved us from the very thing it helped create. Talk about a racket.

Despite what some think, I don’t believe the Federal Reserve acts nefariously. It tries to do what it thinks is best. The problem is that the economy is far too complicated of a system to control, and the law of unintended consequences means that the best decisions now often turn into the worst ones later. Instead of subjectively printing money based on the whims of a dozen, money should be printed at a set rate that never changes. I suggest it be tied to long-term population growth, but the actual rate doesn’t really matter so long as it’s well known and constant.

Keeping it constant means no more moral hazards and no more taxpayer-funded bailouts. The bottom line is that current abnormally low interest rates hurt savers while the very wealthy benefit from artificially propped-up asset prices. Keeping the monetary printing presses steady will eliminate this disparity and will act to restore fairness and stability in the American economy.


Staying silent costs lives

Electrical problem causes fire scare in library