CAPITOL IDEAS: The Fed Has Lost Power
Bethell, Tom
l CAPITOL IDEAS TOM BETHELL The Fed Has Lost Power ~-T'S WORTH COMPARING THE ABSENCE of fuss surrounding the transition at the Federal Reserve Board, now with a new chairman, to the intense...
...The Fed's job is to keep the dollar on an even keel...
...MARCH 2006 THE AMERICAN SPECTATOR 45...
...In fact, it is only vaguely understood...
...Well, who am I to argue with Steve Forbes, who publishes an excellent magazine and has been studying gold signals for years...
...And here we come to a dilemma--a conflict in the messages that markets are transmitting right now...
...But markets are much more sophisticated now, making it harder for debtors to deceive creditors...
...For the private citizen, the important thing is to retain humility...
...Gold has indeed proved to be a reliable early warning indicator...
...if not made permanent, stock market prices could drop by 10 percent or more...
...Another unknown in these uneasy financial equations is the future of tax rates...
...In practice, however, that dismal performance will be hard to repeat...
...Gold, which once played an essential role in the monetary system-dollars could be exchanged for gold at a fixed rate-and was then (by law) banished, in effect forced its way back into the monetary system, although without official recognition...
...They were like technicians at the control panel of a power station, but who didn't know which dials to watch...
...T HE RETIREMENT ACCOUNTS of tens of millions of Americans are directly at stake and the Fed is no longer in a position where it can indulge the political whims of the President or anyone else...
...One possibility is that private wealth is rising in India and China more rapidly than mining operations can add to the supply of new gold...
...It can incur war debts, for example, and pay them off in nominally unchanged but actually depreciated currency...
...The Fed has been "printing an excessive amount of money" Forbes believes, and urges the incoming Fed chairman, Ben Bernanke, to "mop up the excess liquidity until the price of gold comes down to a tad below $400 an ounce...
...They are not normally in conflict and both have been reliable in the past...
...Encouraged by Congress, Fed chairmen often aspire to a more ambitious role...
...Another, China's "ability to flood the world with cheap goods and soak up inflation...
...Steve Forbes takes this as a measure of inflation (which rose by 3.4 percent in 2005), blames the outgoing Fed chairman Alan Greenspan for tolerating it, and adds that he "will have left town before his inflationary blunders become all too evident...
...Theoretically, therefore, it can still do much harm, as it did at the time of the Depression...
...The two jobs are en~_tirely different, of course, but one reason for the disparity of interest is that the Supreme Court has gained enormouslyin power, while the Federal Reserve Board has lost power, to an almost equal degree...
...If the gold price rises noticeably, therefore, it is (perhaps) a sign of inflation...
...Tens of millions of people in those populous countries could well be demanding gold as apersonal hedge against the expropriationist inclinations of their own governments...
...The interest that governments have to pay on long-term bonds would immediately rise to reflect an inflation premium...
...The Fed still has the power to create money out of thin air, meaning that it has the ability to reduce the purchasing power of savings...
...Possibly, then, the gold price is misleading and the long-bond message is more reliable...
...Markets, said Dow Jones Newswires, "have been thick with theories about what is keeping a lid on yields...
...The Fed has no choice but to preserve the value of the dollar, with minimal fluctuation...
...Myself, I do not know whether bonds or gold are the more trustworthy indicators...
...An inverted yield curve is often taken to herald a downturn...
...neither diminishing nor increasing its value by expanding or contracting the money supply too rapidly...
...TOM BETHELL OLD HAS RECENTLY INCHED quite sharply i n alue...
...And since 1997, the Treasury has issued inflation-protected securities, which discourage recourse to inflation...
...In 2003, President Bush reduced tax rates on capital to excellent effect, but the old rates are due to return in 2008...
...If so, the rising gold price cannot be taken as a harbinger of inflation and requires some other explanation...
...The institution he controls is hemmed in and guided by markers and beacons so insistent and strong that policy errors cannot be sustained for long...
...As someone said of personal judgments about the market--"don't fight the tape...
...Hardly anyone in the country knew what was going wrong at the time...
...This is amazing, and in my view needs explaining...
...It would be difficult for that to happen today because red lights on the display panel of the economy would be blinking, market signals would be screeching, and policymakers would be unable to ignore the racket...
...One possibility is a "global savings glut...
...The Supreme Court operates with no such constraints...
...Submit to the numbers-they know more than you do...
...Its spot price in Januarywas about $550 an ounce...
...If it keeps the dollar steady, it will do right by the economy in other ways...
...The accumulation of power by the Supreme Court has been much discussed, so I will say no more about that...
...Another possibility, in opposition to Forbes's view, is that monetary policy is almost everywhere too tight...
...I said that a destabilized market emits distress signals...
...Errors that endured for years in the 1930s now have alifespan of weeks...
...In the end, Ben Bernanke will have to do more or less what markets instruct...
...Forbes is therefore concerned that Bernanke "disdains gold" both as an indicator and as a guide to monetary policy...
...In fact, as I write, the "yield curve" is inverted...
...Wary savers exchanged undependable paper for metal that could not be counterfeited...
...By devaluing its coin, a government can silently repudiate its debts...
...Since the late 1970s, a number of influential analysts have viewed the gold price as an important indicator of the dollar's value...
...The Federal Reserve held the money supply way too tight, and in so doing catastrophically steered the economy off a cliff...
...The yield curve is also inverted in Australia--lenders accept lower interest rates when they lend long-term...
...l CAPITOL IDEAS TOM BETHELL The Fed Has Lost Power ~-T'S WORTH COMPARING THE ABSENCE of fuss surrounding the transition at the Federal Reserve Board, now with a new chairman, to the intense scrutiny given to the new Supreme Court appointee...
...Tom Bethell is a senior editor of The American Spectator and author of the new book, The Politically Incorrect Guide to Science (Regnery Publishing...
...up from $425 a year earlier...
...This appears to be a worldwide phenomenon...
...In the i920s and '30s, the Federal Reserve Board consisted of bankers who didn't quite know what they were doing...
...The loss of much of the Fed's discretionary power over the last 20 years has received far less attention...
...The remarkable fact is that the inflation premium on long-term bonds has all but disappeared...
...You actually pay a lower interest rate to borrow long than to borrow short (4.377 percent on a 10-year note as opposed to 4.378 percent on a 2-year note...
...Gold cannot be printed by the government, and the theory underlying the gold standard is that new gold is discovered at a rate that is roughly proportional to the overall level of economic activity...
...In contrast to earlier times, the government has little incentive to devalue the currency today...
...These bonds pay a fixed rate of interest, but the principal amount is adjusted upward every six months to reflect changes in the Consumer Price Index...
...As to the Fed, these powerful and ceaseless market signals cannot be ignored by any Fed chairman, whatever his private inclinations...
...But my concern is that another reliable harbinger of inflation has been sending a very different signal...
...A Wall Street Journal reporter noted that the yield on Britain's 50-year gilt "fell to a record low of 3.48 percent this week, prompting the pension industry to call on the government to issue more long-term debt...
...But all these goals are inappropriate to the 44 THE AMERICAN SPECTATOR MARCH 2006 Fed's function...
...playing with the unemployment dial, for example, or urging the economy to grow at a certain rate, or delivering sermons against budget deficits...
...In the 1970s, when inflation spiked twice and reached i3 percent in one year, long-term interest rates rose to 15 percent and the gold price exceeded $850 an ounce...
Vol. 39 • March 2006 • No. 2
