Monetary Risk: Blinder Is Only Half Right

Former Fed vice chairman Alan Blinder warns of the dangers of slowing the central bank's printing presses too early and thereby repeating the mistakes of the mid-1930s. As he explains,

From its bottom in 1933 to 1936, the G.D.P. climbed spectacularly (albeit from a very low base), averaging gains of almost 11 percent a year. But then, both the Fed and the administration of Franklin D. Roosevelt reversed course.

In the summer of 1936, the Fed looked at the large volume of excess reserves piled up in the banking system, concluded that this mountain of liquidity could be fodder for future inflation, and began to withdraw it. This tightening of monetary policy continued into 1937, in a weak economy that was ill-prepared for it.

Blinder is right to warn against ending the liquidity injections too early. But that doesn't mean the party should go on forever. In a sign of the times, however, Blinder's mum on identifying that magic day in the future when the ambitious expansion of the money supply and the Fed's balance sheet should end and the monetary tightening should begin. He's quiet on this point for a very good reason: He doesn't know the date. Nor does anyone else, and therein lies the great challenge confronting the U.S. economy, and one that Blinder avoids discussing in his otherwise salient article on Sunday in the New York Times.

Overlooked or not, there will come a day when the great countercyclical monetary operations of the Fed should cease and desist. That doesn't mean that the efforts to juice inflation will end, at least in a timely manner. To the extent that they don't and they should, the American economy will suffer. Inflation, in sum, lurks in the future, just as it always has and always will. That's the nature of paper money. The issue is one of deciding to control the beast, and it's never too soon to plan ahead.

There's no imminent danger, of course. The seasonally adjusted consumer price index was flat last month and over the past year it's fallen 0.7%. Clearly, there's no pressing reason to raise interest rates at the moment, nor does the futures market expect Fed funds to rise any time soon. But as the Fed's aggressive monetary actions over the past year become deeply embedded in the economic fabric, expecting inflation to remain dormant indefinitely is expecting too much. Indeed, the Fed is effectively spending all its efforts on reviving inflation, and we, for one, think that it'll be successful.

So, too, does the man running the Fed, or so he said when he was a Fed governor expounding on the powers of the printing press when it's controlled by a resolute central bank intent on devaluing the currency, a.k.a., creating inflation. The trick at this juncture is to devalue just a bit so as to perk up the economy without unleashing disagreeably high levels of inflation. Meanwhile, it's hard to overlook the fact that the mountain of debt piling up on the U.S. government's balance sheet would be eased as inflation rises. Paying lenders back in devalued currency has more than a little precedent, and it's hard to believe that the allure will hold no sway in Washington in the years ahead.

In any case, Bernanke is confident about the prospects for elevating the general level of prices, or so he said back in 2002, explaining that "under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

The use of the word "always" sounds rather definitive. The only question is timing. So, yes, Blinder's counsel that the Fed should be mindful of raising interest rates too early and thereby repeating the mistakes of 1936 is germane. But let's remember that his advice addresses only half of the monetary risk that awaits. At some point, the economic trends will shift and waiting too long to raise interest rates will be the primary hazard. We don't know if the turning point will come in a few months or a few years, but we shouldn't delude ourselves that it's never coming.

Comments

[Larry House:]

One thing I know for sure, and history bears this out, there is ZERO chance that the government will get the timing right. It has never happened.

May 19 04:04 PM

[The Geoffster:]

If inflation is always a monetary phenomenon then government can always induce inflation by creating more fiat currency. Now that moral hazard has been sidelined in favor of central planning, it's impossible to know when the bail outs will end. It looks like any large industry is ripe for government funding. My guess is it won't end until foreigners quit buying our debt or inflation results in a change of government.

May 19 10:09 PM

[johngonole:]

The US voters will be foaming at the mouth when prices shoot through the roof. They will once again ask for change totally ignorant of the fact they are getting exactly what they asked for and deserved. Most really don't understand anything about economics. Those who do (myself included) are obviously too comfortable to make much of a fuss. After all a bird in hand is better than a flock in the bush.

After every cycle of the the Fed trying to counter cycles with monetary policy we end up with higher government debt levels, more medicare and social security obligations unfunded, and a larger percentage of society dependent on government spending. And I'm not just talking about welfare and wealth transfer mechanisms which are certainly a large problem. But more and more people as a percentage of the work force are employed by government agencies. Furthermore much of the private sector makes its money on government spending or projects.

If 30% to 40% of what we make ends up in the hands of government institutions via taxes and then we adjust for the fact that governments on all levels are spending more than they bring in and thus issuing bonds then its not a strech to conclude that about half of our resources are controlled or allocated via government spending decisions. Obviously local government can allocate the resources better but that is an argument for another time.

Where I'm going with this is that after every cycle we end up with government controlling a larger and larger portion of our economy as well as how wealth and resources are distributed. With higher national debt levels also occuring future generations will have very little economic freedom. We the people are losing control of how are resources are allocated. We are ceding control to large, inefficient, BLIND monopoly where the right hand can't possibly know what the left hand is doing.

Inflation will be the only way out. Rampant inflation must lead to smaller government control or this country will go the central planning route where the government ends up owning and controlling everything.

Massive inflation might just be the political fulcrom point as the security cushion of the baby boomers is wiped out.

May 19 11:04 PM

[Missing_Link:]

For proof, read "Secrets of the Temple: How the Federal Reserve Runs the Country" by William Greider: www.amazon.com/Secrets...

On May 19 04:04 PM Larry House wrote:

> One thing I know for sure, and history bears this out, there is ZERO
> chance that the government will get the timing right. It has never
> happened.

May 20 12:11 AM

[Missing_Link:]

Inevitably, the federal government will need to have a conversation with the people and explain that all the promises piled upon promises made by previous presidents, all the massive entitlement programs, the Medicaid, the Social Security and Medicare that are now 44% of our budget (the entirety of defense spending is only 22%!), all of Obama's additional promises upon that, are promises we can no longer keep.

With the consumer, corporations, banks, state governments, and the federal government all up to our eyeballs in debt, and all our entitlements as another layer of debt upon that, we need to backtrack, and it's impossible.

Admitting the truth is political suicide.

Any President who actually tried to put his fingers on the crutches on which so many Americans now rely would be gone in an instant.

The only way we'll ever be able to get to the point where we can confront it is if the federal government gets into such a financial crisis that it has no other choice. The federal government would have to financially explode, Mr. Creosote-style www.youtube.com/watch?... , before that happened.

My best guess is that the government and the Fed are doing everything in their power to actually engineer exactly such a meltdown. It's the only rational explanation I can come up with for the current administration's insanely risky, if not suicidal, economic policies.


On May 19 11:04 PM johngonole wrote:

> The US voters will be foaming at the mouth when prices shoot through
> the roof. They will once again ask for change totally ignorant of
> the fact they are getting exactly what they asked for and deserved.
> Most really don't understand anything about economics. Those who
> do (myself included) are obviously too comfortable to make much of
> a fuss. After all a bird in hand is better than a flock in the bush.
>
>
> After every cycle of the the Fed trying to counter cycles with monetary
> policy we end up with higher government debt levels, more medicare
> and social security obligations unfunded, and a larger percentage
> of society dependent on government spending. And I'm not just talking
> about welfare and wealth transfer mechanisms which are certainly
> a large problem. But more and more people as a percentage of the
> work force are employed by government agencies. Furthermore much
> of the private sector makes its money on government spending or projects.
>
>
> If 30% to 40% of what we make ends up in the hands of government
> institutions via taxes and then we adjust for the fact that governments
> on all levels are spending more than they bring in and thus issuing
> bonds then its not a strech to conclude that about half of our resources
> are controlled or allocated via government spending decisions.
> Obviously local government can allocate the resources better but
> that is an argument for another time.
>
> Where I'm going with this is that after every cycle we end up with
> government controlling a larger and larger portion of our economy
> as well as how wealth and resources are distributed. With higher
> national debt levels also occuring future generations will have very
> little economic freedom. We the people are losing control of how
> are resources are allocated. We are ceding control to large, inefficient,
> BLIND monopoly where the right hand can't possibly know what the
> left hand is doing.
>
> Inflation will be the only way out. Rampant inflation must lead
> to smaller government control or this country will go the central
> planning route where the government ends up owning and controlling
> everything.
>
> Massive inflation might just be the political fulcrom point as the
> security cushion of the baby boomers is wiped out.
>

May 20 12:45 AM