Congress and the Fed: An Epic Game of Chicken

WIth the Federal Reserve worried about its independence, it has a Faustian bargain to make: keep its independence, or keep interest rates low.

Essentially, many in Congress would like to see the Fed keep interest rates lower for longer than it might if left to its own devices, in order to stimulate employment. It is a frightening prospect that pressure is being brought to bear on Chairman Ben Bernanke to keep monetary policy loose--the same Chairman who once wrote that the Fed could drop money from helicopters, if necessary, to prevent a severe deflation.

If the purpose of Fed independence is to keep monetary policy independent from politicians, who always prefer inflationary policies, it is essential that Ron Paul's bill, which seeks to audit the Fed (a necessity) is not used as a backdoor method by Congress to gain control over monetary policy.

Bernanke is in a tough position. He wants to maintain the Fed's prerogatives to set monetary policy. However, to do so, he may be tempted to bend to the will of Congress and keep interest rates lower than he might otherwise in the absence of external pressure.

If power is the ability to influence, then Congress, in practice, has huge power over the Fed if it's Chairman allows himself to be tempted to make the Faustian bargain of keeping interest rates low, in return for the maintenance of Fed independence. If Bernanke does not show backbone, Congress would not even have to pass a bill giving itself more power over monetary policy. It would simply have to threaten to do so every time it was unhappy, holding the Fed hostage to political whims. To his credit, Ronald Reagan supported Paul Volcker's inflation fighting stance, however unpopular with Congress. Chairman Bernanke should be similarly supported by President Obama in the area of monetary policy independence.

Distrubingly, the New York Times' Edmund Adrews noted on November 11.

Voters had become suspicious and unnerved by the Fed because of its trillion-dollar efforts to bail out the financial system, Mr. Frank warned. If the Fed really wanted to survive the disgruntlement in both parties, he continued, Mr. Bernanke would have to step back and let him devise a compromise.

Reluctantly, the Fed chairman agreed to reduce his own visibility on the issue and let Mr. Frank take the lead.

This is exactly the wrong approach for Chairman Bernanke to pursue. Rep. Frank is a shrewd politician. The scenario which is unfolding should be a familiar one to Chairman Bernanke if he has ever been pulled over for a questionable "traffic violation." It's good cop-bad cop. "We'll help you, just stop fighting us." Congress does not want to help the Fed. Like any institution, it wants to expand the sphere of its own authority. Can anyone guess who will have more power under any compromise bill? House Financial Services Committee Chairman Barney Frank.

Compromise on monetary policy is a fool's errand. Instead, the Chairman Bernanke should take a hard line, conceding that the Fed over-stepped the bounds of prudence in supporting problem banks and agreeing to tighter strictures in that area, while vehemently fighting to protect the Fed's prerogatives in setting interest rates. If the Chairman does not, long-term inflation, and indeed, hyperinflation could result.

Otherwise, if Bernanke succumbs to the temptation of appeasing Congress by keeping interest rates artificially low (which is what most members of Congress really want), he will have given up his power without a fight, and more importantly, compromised the integrity of the very currency whose value he is mandated to protect.

Bureaucracies have a bad record when its comes to a question of the public interest vs. the perpetuation of the bureaucracy. Unfortunately, it looks like Bernanke may have already made his choice. Earlier this week, multiple Federal Reserve officials gave speeches around the country, openly stating that the need to spur jobs was worth the risk of inflation. This is a clear message to Congress: “We'll do what you want, just leave us alone.” It's also a clear message to investors. More inflation is coming.

The Fed needs to educate Congress and to fight for prudence. Higher prices hurt ordinary citizens when their dollars don't go as far. When citizens can afford less, it hurts demand for good and services, reducing GDP growth and employment. It's a simple argument, and it's the right argument. The Fed should make it.

Disclosure: Author holds a long position in GLD

Comments

[larethdf:]

This is pretty backwards, it seems. The Fed is an inflation creating monster that has already destroyed over 95% of the value of the dollar since its creation in 1913. There is no Constitutional authority for a central bank, and our founders warned strongly against it from the very beginning. Certainly it should be audited immediately, but it may already be too late to stop serious price increases. Ron Paul has been quite outspoken against the ridiculously low interest rates already in effect, and this is the driving force behind the public's distrust of the Fed, and the concept of fiat currency in general. The first thing we should do is legalize competing gold and/or silver backed currencies, such as the silver certificates that JFK had issued. Interest rates should be based on available savings, not the whims of presidential appointees who disingenuously claim that they are not influenced by politics. If you really believe that line, perhaps there's a bridge you'd like to invest in.

Nov 12 04:42 AM

[Steve in Gr...:]

Thanks, Mr. Long, for the thoughtful article.

The performance of the post-Volcker Fed has been a disaster for the U.S. economy. Quoting from the 11/11/09 article from SA contributor "Economic Disconnect":

"...what US institution did the following:
-goosed the money supply before the Y2K hoax which led to a spectacular blow off top in the stock indices?
-goosed the money supply in response to said blow up in an attempt to mop up their own mess
-goosed the money supply in such a way that has never been seen before in the history of the USA in order to mop up the mess from the goosing from the last time."

I agree that having monetary policy set by politicians is a very frightening prospect. But I am not sure if even the current crop could have done any worse than the last two Fed chairmen.

The solution to money supply management is probably something like a currency board with a charter to keep the USD fixed against a basket of other currencies and gold.

But this solution will probably have to wait until the complete, hyperinflationary collapse of the USD, because the government never willingly gives up power. The good news is we don't have too much longer to wait.

Nov 12 05:24 AM

[doubleguns:]

In this game of chicken these idiots forgot that we the people are all in the back seat. If they kill each other off in the wreck that is fast approaching I do not want to be in the back seat.

Problem is there is no getting out now.

Nov 12 09:13 AM

[yellowhoard:]

Whoever pushes for silver backed US currency probably ought to avoid riding in convertible cars.


On Nov 12 04:42 AM larethdf wrote:

> This is pretty backwards, it seems. The Fed is an inflation creating
> monster that has already destroyed over 95% of the value of the dollar
> since its creation in 1913. There is no Constitutional authority
> for a central bank, and our founders warned strongly against it from
> the very beginning. Certainly it should be audited immediately, but
> it may already be too late to stop serious price increases. Ron Paul
> has been quite outspoken against the ridiculously low interest rates
> already in effect, and this is the driving force behind the public's
> distrust of the Fed, and the concept of fiat currency in general.
> The first thing we should do is legalize competing gold and/or silver
> backed currencies, such as the silver certificates that JFK had issued.
> Interest rates should be based on available savings, not the whims
> of presidential appointees who disingenuously claim that they are
> not influenced by politics. If you really believe that line, perhaps
> there's a bridge you'd like to invest in.

Nov 12 09:18 AM

[Moon Kil Woong:]

I think the author got it wrong. Bernanke like Congress has every intention on keeping monetary policy loose too. In fact what bothers Congress is that the Federal Reserve with QE basically has hijacked the dollar. There is now nothing the Fed can't do. This is a fight between power. Congress having the power to make money, tax, and spend vs. the federal Reserve that wants the power to make, money, deflate, spend, and also regulate like the executive branch.

The simple fact is the Federal Reserve is a good political scapegoat to blame for the mess we are in. The ironic thing is they are actually the culprits.

Nov 12 09:42 AM

[robert.b.fe...:]

Volecker did indeed enjoy the confidence and support of President Reagan. Unfortunately for us President Obama has all of the back bone of a chocolate éclair and can barely make a decision to blow his nose without a four month deliberation and a comity to defray the blame. What kind of support do you think Helicopter Ben will get? Nancy will you please give Barak his gonads back?

Nov 12 09:58 AM

[Gedankonomist:]

"If the purpose of Fed independence is to keep monetary policy independent from politicians, who always prefer inflationary policies..."

And the shadow government that wants to keep the FED "independent" (read: unaccountable), they want what? What's best for you and me?

Duh!?

Nov 12 10:04 AM

[Smarty_Pants:]

Ummm, the only way the FED can raise interest rates over the long term is to start selling assets currently on the FED's balance sheet. The majority of those assets are toxic debt related crapola purchased/loaned in order to keep the big Wall Street banks/GSEs afloat.

Who do you forsee as being the buyer of all that toxic junk when the time comes to raise interest rates???

Ain't gonna happen, I'm a-thinkin'.

Nov 12 10:15 AM

[Harry Long:]

I agree. There is no question that the free market should set interest rates, rather than the Fed's artificial price-fixing when it comes to interest rates.

The only thing I would add is that every country which has not had an independent central bank, unfortunately, has inflation worse than our own.

But totally agreed, with the exception of Paul Volcker, a truly exceptional human being, the Fed has created terrible inflation.


On Nov 12 04:42 AM larethdf wrote:

> This is pretty backwards, it seems. The Fed is an inflation creating
> monster that has already destroyed over 95% of the value of the dollar
> since its creation in 1913. There is no Constitutional authority
> for a central bank, and our founders warned strongly against it from
> the very beginning. Certainly it should be audited immediately, but
> it may already be too late to stop serious price increases. Ron Paul
> has been quite outspoken against the ridiculously low interest rates
> already in effect, and this is the driving force behind the public's
> distrust of the Fed, and the concept of fiat currency in general.
> The first thing we should do is legalize competing gold and/or silver
> backed currencies, such as the silver certificates that JFK had issued.
> Interest rates should be based on available savings, not the whims
> of presidential appointees who disingenuously claim that they are
> not influenced by politics. If you really believe that line, perhaps
> there's a bridge you'd like to invest in.

Nov 12 11:13 AM

[repofinder:]

The Fed needs to be gutted and rebuilt. Our current banking industry is like a bull in a china shop leaving a wake of destruction (see: www.repofinder.com ). We encourage Americans to get in debt then kill the economy with greed and over regulation in the credit markets.

Nov 12 05:53 PM