Greenspan Argues Against the Fed

Former Federal Reserve Chairman Alan Greenspan has not explicitly argued against the Federal Reserve Bank or any other central bank, except in his long-ago essay on gold in the collection of essays entitled Capitalism: The Unknown Ideal. As Chairman of the Fed for 18 years, I find it unlikely he has contemporaneously and explicitly disavowed the institution he helmed for such a long period of time.

Nevertheless, he did make quite an effective, albeit unintentional, argument against the Fed on his 60 Minutes interview Sunday night. The interviewer asked whether he was to blame for the sub-prime mortgage crisis by making credit too easy. Greenspan said that he was aware at the time that questionable mortgage credit was being extended by banks, but he admitted he was unaware how pervasive it was or how impactful on the economy. He just didn't see the problem as it was developing.

That is his argument against the Fed, whether he realizes it or not. No central banker, no matter how good, can possibly hold in his mind all relevant information to centrally manage the money supply and credit of an economy. Such is the fallacy of central planning. It doesn't work in banking, just as it has never worked in any other area of an economy. The collapse of Communism is proof of that. So is the failure of the centrally managed parts of our mixed economy, such as public schooling and public housing.

Greenspan is smart, but no single man or woman is smart enough to be a central planner.

Helicopter Ben

"Helicopter Ben" is the nickname Federal Reserve Chairman Ben Bernanke reportedly got for a comment he once made regarding how the government should aggressively use monetary policy to prevent a recession. Emphasizing that the key point is to inflate quickly to avert a crisis, he said the government could simply drop money from a helicopter to stimulate the economy.

Federal Reserve chairmen like to fly around in helicopters. Maybe that's their problem. By attempting to manage the money supply from their helicopter vantage, the Federal Reserve fails to see the real action of the economy on the ground. As a result, they make bad decisions. They add too much money or too little. They act too early or too late. The result is an exacerbation of booms and busts in the economy. The booms become unreal, and the busts too severe.

In 2003, the Federal Reserve lowered the interest rate at which it facilitates bank loans to an unprecedented low of 1%. In those years, we saw tremendous investment in real estate and a boom in real estate prices. The excess investment was stoked by cheap credit for mortgages available from banks. Variable interest and interest-only loans keyed to the artificially low federal funds rate enabled homebuyers to bid ever more for larger houses. Easy 100% or more financing enabled those who hadn't saved for a down payment to buy houses on the bank's credit.

Artificially cheap money had led to a flood of financial capital becoming available for mortgage lending by the banks. Lend they did, at terms that did not reflect the true financial risk they were undertaking. Such artificially supplied cheap money is inflation. When the Fed realized that its inflation of the money supply led to inflated asset prices, it tried to limit the damage by tightening credit, eventually raising the bank interest rate to a recent high of 5 1/4%. Now, the reverse process is happening. Over-extended borrowers are defaulting, credit is tightening, and the economy is poised for a slow-down.

All of this is the result of managing monetary policy from way up high in helicopters. How do we bring monetary policy down to earth? The only way to do this is to privatize money. Instead of the Federal Reserve, a sole, legal monopoly issuer of money and credit, all money should be issued by private banks. Private banks do not operate in helicopters. They operate on the ground. They understand the specific financing needs of particular borrowers. They assess their ability to extend credit based on the creditworthiness of the borrower, and on their own availability of funds.

The supply and demand conditions of money and credit that the banks respond to are the real economy. If a new technology creates promising new business opportunities, the banks lend to those businesses. If a regional downturn reduces creditworthiness, they extend less credit. All the time, the banks lend with a view to protecting their own balance sheets and maximizing their own profit. This grounded action by private banks will result in the most efficient deployment of financial capital possible.

Does it mean the end of booms and busts? That is a question I am not sure of, but I think it may not. Nevertheless, the booms and busts that will occur will be shorter in duration and less severe. More importantly, they will reflect real economic events, not artificial changes of the money supply by the helicopter money monopolists.