Winter Of Discontent

As global markets plunge for reasons I've long warned about in this space, I'm seeing a lot of apocalyptic gloating from bears who seem to view all this in a vacuum. But let's be clear: no one reading this has an interest in a repeat of the 1970's or 1930's. Even if you're short the market and long oil and gold out the wazoo, and stocks crash while oil goes to $200 and gold to $2,000, your profits ultimately will be rendered moot by the declining standard of living around you -- you or your family members losing jobs, your house losing value, your kids' school cutting back on resources, your local hospital not hiring a much-needed specialist or building that new wing, that bridge you drive across every day not getting repaired. We all have an interest in policymakers succeeding.

I'm very worried about the chances of that happening. It may be understandable, because nothing really changes until a crisis passes, but the "solutions" being batted around are little more than retreads of what got us here in the first place. Policymakers both elected and appointed have spent the past ten-plus years trying to repeal the economic cycle. There's always been a crisis to ameliorate, an election to make things look good for, a war to pay for, an ass to cover. This has resulted in two of the largest speculative bubbles (and subsequent busts) in human history, at least one and almost certainly two recessions, all-time highs in oil and gold, bulging national coffers for non-allies including Russia, Iran, and Venezuela, the uniquely American concept of upward mobility discredited for millions of experience-hardened erstwhile home owners, and dollar-inspired belly laughs from the desks of the world's largest central banks to the cardboard countertops of black market currency changers in Kinshasa and Kathmandu. That's quite a record of achievement for any ten-year period. Regular readers also know my belief that it was, at least in part, the Bush administration's desire to avoid blame for the consequences of bad monetary policy that got us into a war and open-ended occupation on a false pretense.

Some headlines from the past few weeks:

• "The Fed to the rescue"
  
  
• "Fed puts up united front to rescue weak economy"
  
  
• "Bernanke to the rescue as stocks fall"
  
  
• "Washington To The Rescue"

Recall this passage from Bresciani-Turroni:

The eyes of all were turned to the Reichsbank. The pressure exercised on it became more and more insistent and the increase of issues, from the central bank, appeared as a remedy....

The authorities therefore had not the courage to resist the pressure of those who demanded ever greater quantities of paper money, and to face boldly the crisis which...would be, undeniably, the result of a stoppage of the issue of notes. They preferred to continue the convenient method of continually increasing the issues of notes, thus making the continuation of business possible, but at the same time prolonging the pathological state of the German economy....

It is certain that the rise in home prices, which was the immediate consequence of the depreciation of the exchange, had given a definite thrust to the increase of note issues and of the floating debt.

But it is important not to forget that that last stage of the depreciation of the mark was, in a great part, the direct consequence of an erroneous financial policy in the preceding years. Besides, the increase of the note-issues, following the increase of home prices, was not at all a necessary action, as some writers seem to believe. An energetic financial and monetary policy and a more circumspect banking policy would have broken the vicious circle....

In this sort of environment, concerns about political influence on the Federal Reserve, while valid, are almost beside the point. One of the destructive effects of monetary policy since the mid-90's has been to turn the stock market into the country's moral support system. It's become the most accurate barometer of public psychology. That's made the Fed chairman psychologist-in-chief, and created a perverse situation in which the nanny state, by giving Americans their sense of purpose and self-worth via the stock and real estate markets, usurps the role of family, neighbors, schools, and churches. Greg Djerejian coined the phrase "surge nation" last year in a post about Iraq, and it describes the Fed's role perfectly. As I argue in this piece in The American Conservative, this should deeply offend those conservatives who understand what's intrinsically valuable about this country. But as long as monetary fixes take the place of "hard work" by elected officials on issues like education and trade, and the Fed does nothing to dispel the perception of itself as "keeper of the flame of national purpose," the destructive boom/bust cycles will worsen. What might change this? A rediscovery, as a nation, of those natural, traditional support systems. This would pave the way for the next move up, economically as well as geopolitically, because the "surge" would come from within instead of a short-timer politician or a Beltway statist with his finger on the interest rate button. That sort of rediscovery and spiritual awakening comes only from hardship, so Washington will do everything possible to prevent it.

Of course it's easy to sit here anonymously criticizing policymakers who are in the trenches dealing with this stuff every day and getting pulled in a dozen different directions. So if I had five minutes with Ben Bernanke, here's what I'd tell him (and I know this blog has readers at the Fed, so maybe someone will send him the link). In terms of his legacy, he's already got one foot in the grave. He can either jump all the way in and start shoveling the dirt onto his own head by taking rates down to 3% or 2% or 1%, or he can take that shovel, bash the ghost of Rudolph Havenstein in the head, and show some Volcker-esque leadership (Volcker, by the way, worked under far more difficult circumstances). If Bernanke does the latter, he needs to tune out the chair-throwing TV pundits (who care only about their ratings and website subscriptions) and make a major speech in which he states clearly that monetary policy earlier this decade veered too sharply in one direction, and that the Fed cannot be expected to cure all ills. My recollection is that he flirted with this notion in a speech a year or two ago, but promptly dropped it after the next down day in the stock market. If he wants to cut rates another quarter or half-point here, fine, as long as he makes that speech then follows up with appropriate policy. It may cause some short-term pain and affect the Fed's cherished "flexibility." But it will assuage foreigners on the dollar (crucial right now), make speculators think twice during the next up cycle, and encourage economic activity by spurring those waiting for ever-lower rates to borrow now.

The alternative? Monetary policy as usual, with heaping portions of expediency and no doubt some taxpayer-financed bailouts, eventually sending oil well over $100, gold to $1000 and higher, and the dollar further into the crapper. Then, when all that hits the economy, lower rates again. Wash, rinse, repeat, until the next war or terrorist attack provides some much-needed cover by conveniently distracting voters from the failure of policy and providing an excuse to take rates back to 1%. (Can there be much doubt that some in Washington would secretly welcome that scenario right now?) Keeping in mind that Bernanke's scholarly interest is the Great Depression and he once promised Milton Friedman that "we won't do it again", which path do you think he'll choose?

Meanwhile, for those who can't be bothered with all this and just want to know who to blame as they watch the stock and housing markets plunge and the job market dry up, culpability should be in this order: Bush, Greenspan, Bernanke. Bush, for presiding over one of the most stunning reversals in a nation's economic position ever, in which the economic and moral costs of a war of choice played and continue to play an important role; Greenspan, a latter-day John Law, for blowing the monetary bubble (at least Law had the decency to slink off to Italy after he was discredited; here, he would have written a book and made speeches); and Bernanke, for overseeing the bubble's important final stage, during which he did nothing (until the last week or so, perhaps -- long after the damage was done) to dispel the market's perception of him as a monetary Santa Claus.

If the polls and the likely outcome of November's election are any indication, most voters already get it.