The Fed's Conceit

(in imitation of J.P. Donleavy’s The Ginger Man*)

“‘Some place. What holds it up?’

— from The Ginger Man

TODAY, A RARE SUN in winter. Sun burns bright in the East. In the halls of Congress, men in dark suits gather in an impressive room with wooden panels and high ceilings and dead men looking on from paintings on the wall. Cameras around. Microphones and notebooks. Mustn’t miss a thing. Something important is about to happen.

The new Fed chief stands solemnly before the Congress. He is well groomed. Neat beard. Dark suit and striped tie. Confident and beaming. Nice central banker. Good little bureaucrat.

He states the economy is progressing along nicely. Yes. As if he were charting the pacing of an elephant. Certain and predictable. Easy to watch and not too complicated.

Not so, not so. The economy is far more complex and far bigger than this one man — or any man — could ever know. Perhaps he knows of this conceit, perhaps he is just playing to the fools he knows will eat it up.

People — smart and dumb, young and old — persist in believing that Fed is somehow in control of it all. They hang on his every word. As the Greeks once waited with bated breath for the Delphic oracle’s latest whispers.

And people praise the old Fed chief, Alan Greenspan. A good job he did, they say. And how do they know? They don’t know. How did he do a good job, exactly? How do we know if he pushed the right buttons or pulled the right levers?

Greenspan was a fraud, perhaps a lucky one. This new lad is also a fraud, though he may not be so lucky. The Federal Reserve rests on a tangled thicket of conceits. But I’ve gotten ahead of myself…

Recently, BCA Research, a respectable mainstream firm, finally asked the question: DO WE NEED A CENTRAL BANK? A most stunning answer they give.

They couch it with the usual mealy-mouthed caveats of Wall Street’s mush and milk thinkers. This is an unfortunate consequence of being “respectable.”

They begin, weakly, like an invalid stepping out of bed for first time after many weeks: “While we are in no way suggesting or condoning the Federal Reserve or other central banks shut their doors tomorrow…” No, of course, not. That wouldn’t be respectable, would it?

They go on to say: “The question of whether or not we need a central bank may seem far-fetched or even ridiculous to ask…” Yes, yes, more apologies. This is why I don’t work for Wall Street. Because I would be forced to write sludge like that. Can you believe people pay good money for this sugarcoated stuff? Just lay it out there and give it to me good and hot.

 Nonetheless, the analysis itself, once they get around to it, is quite damning of the Fed’s relevance.

In older days, monetary policy was quite important and had a big impact, as anyone who lived through the inflationary ’70s — and Volcker’s tightening — can attest to. Tighten and tuck. Just so.

No more does the Fed’s little lever-pulling seem to have such an effect. There are new challenges. These, say the BCA, are characterized by “the diminishing impact of monetary policy on domestic economies and the increasing prominence of the self-regulating powers of financial markets.” Eee!

The market does not do what the Fed wishes. Rates stayed low in 2004. Yet the Fed tightened. Still so today. “U.S. bond yields remain incredibly low against the backdrop of a very hawkish central bank, a large current account deficit, and gaping U.S. public borrowing requirements.” In any event, it seems that Fed can’t control the markets quite so well with the tightening like it once did. The falcon no longer heeds the falconer.

In the meantime, so says the BCA, the market shows a stiff upper lip and adapts well to changing conditions. Sharp currency changes have helped to balance out things and smooth out the edges of the global business cycle, the BCA maintains. BCA furnishes examples where markets have self-adjusted to varying problems.

Why the impotence of the Fed?

The market for money is global and it is deep. It has outgrown country boundaries. It is bigger than the Fed. Investment dollars flow more easily from place to place than ever before. You cannot control something so free and so large.

Second, BCA maintains that the explosion in global trade has greatly increased efficiency — dampening inflationary tendencies of central banks. This is similar to the argument that productivity gains absorbed much of the price inflation that otherwise should have occurred given the Fed’s loose monetary policies. A spigot of easy credit they were.

So the growth of trade and increasing efficiency have made global markets more important than any single country’s central bank. The U.S. economy has slipped the harness that the Fed pretends it wears.

Who is the driver now? Not the Fed. As BCA concludes: “The forces of globalization have diluted the power of the domestic central bank.” The Fed would rather you not know that.

What it means is the Fed will be pretty useless come the next global financial crisis. It can’t prevent one any more than it can solve one.

The depth of the Fed’s conceit extends even further than BCA admits. Consider the rate of price inflation.

Amusing, isn’t it, how the inflation rate has been parsed? There is the core rate, which the Fed prefers, because it is lower — currently around 2%. Then there is the headline rate, which is between 3-4%. Funny that. Imagine walking into a store. How much is this? Oh, really? Is that the headline or the core rate? I’d prefer the core rate. Thank you very much.

Beyond these two measures is the real rate — not talked about by the Fed, like a fussy old aunt the family is embarrassed to discuss. This is the rate real people pay — as they open their home heating and credit card bills, send kids to college, renew insurance coverage, pay for medical expenses, gasoline, and property taxes. You know, all the minor things like that.

The Fed would rather have you believe that it is an inflation fighter, as opposed to the one who lets the beast out. No need to repeat the staggering loss in the dollar’s value since the creation of the Federal Reserve. Suffice it to say, the Fed is more like the firemen who start fires they can then put out.

Those are two conceits. One, the belief it is some sort of helmsman of the U.S. economy. The other is this idea that the Fed is an inflation-fighting institution.

I could go on. But ’tis getting late. The sun is weak. Night wakes up. The wind blows hard. On a distant road on a winter’s eve, the sound of cars rumbles faintly. How little the drivers know of the Fed’s new man and the Fed’s great conceits. They believe in them. How long will such charades continue? May we live to see the day of the Fed’s demise. When the answer to BCA’s grand, if belated, question is an unequivocal no.

* Donleavy wrote in a distinctive style. The Ginger Man, nominated by Modern World Library as one of the 100 greatest novels of all time, is the story of a charming rogue, Sebastian Dangerfield, studying at Trinity College in post-World War II Ireland. The book is full of booze, sex, violence, and foul language as it chronicles Dangerfield’s self-destructive behavior. In other words, it’s a blast. It came out in 1955 and was immediately banned in various places. Not for schoolmarms or Puritans.

Chris Mayer
February 22, 2006