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Richard Ebeling was right about the Federal Reserve in 1999...and he's right now.

Way back in 1999, through the heady days of the tech boom and adulation of Alan "Maestro" Greenspan, I interviewed a prescient economics professsor: Richard Ebeling of Hillsdale College. His is a prescience based on simply being grounded in reality, rather than hype, mathematical models or self-delusion.

He was right about the damage the Federal Reserve was doing to the economy back then, and he's right now. He was also right about the damage many economic forecasters were doing to the economics profession (modern "witch doctors," he calls them)... and he's right now.

As policymakers and economists do some much needed soul-searching, there's great clarity and guidance here from Ebeling about what the profession is supposed to be about in the first place.


HILLSDALE -- A bad case of the shakes swept through U.S. financial markets last fall as Asian markets nose-dived, Russia's economy imploded and a major investment fund nearly went bust.

Lenders bolted from the credit markets, putting U.S. economic growth at serious risk. The Federal Reserve came to the rescue and pumped credit into the system, forcing down short-term interest rates.

That was a mistake, said Richard Ebeling, economics department chief at Hillsdale College. He believes the Fed made a bad situation worse.

Ebeling has written and edited numerous articles and books on economics and is now at work on a 20th century history of U.S. monetary policy.

Q. The conventional wisdom is that Alan Greenspan's Fed has done a great job for the U.S. economy. You don't agree?
A. I don't mean to belittle Alan Greenspan, but a central bank in charge of managing the supply and value of money works under the dubious assumption that central planning by a handful of people -- however brilliant they may be -- can work efficiently. It's now accepted that central planning in the Soviet Union failed. An economy is too complex to successfully coordinate from the center. If that's true, and we accept that central planning couldn't successfully deliver shoes, hats, glasses or bread in the USSR, why should we believe it's possible for a central bank to successfully influence the money supply and interest rates?

Q. Isn't finance different?
A. There's a price for hats, cigarettes and pens. Interest rates are a price -- the price of borrowing. There's only one way to know the "right" price -- supply and demand. We all know that if the government sets the price of a hat higher than what consumers think they're worth, a lot of inventory will sit on the shelf. Government pushing interest rates too low or too high causes distortions in financial markets just as price-tampering does in any other market.

Q. Greenspan seems to have done a good job. Growth is strong. Inflation is dead. What's the big deal?
A. The first edict of every physician: "First, do no harm." Greenspan has done less harm than other Fed chairmen. He's been more moderate using the printing press. That's all I can say in support of him.

Q. Why not let the Fed continue? What's the threat?
A. One threat is that Fed governors are appointed for 14-year terms. Sometimes they resign or retire earlier. Greenspan's either going to be reappointed or not. Well, what if he's not, even though he has been a "good guy"? In any case, we have no idea who the next Fed chairman will be. We have no guarantee that what seems to have been a relatively inflation-free environment will continue. The money supply is now determined by changing political currents and personalities.

Q. You've compared the current boom to life before the great stock market crash of 1929. What caused the crash?
A. In the 1920s, the Federal Reserve came under the influence of an American economist named Irving Fisher who said the best monetary policy was price stability -- no inflation, no deflation. The Fed tried to establish Fisher's rule by manipulating the money supply. The 1920s was a period of great growth, innovation and lower production costs. Prices should have fallen, but they were generally stable. The Fed increased the money supply throughout the 1920s to combat what would have been a healthy price deflation. So through a good part of the 1920s, interest rates were artificially low. Finally, in 1928, prices began to rise because of all of the money and credit the Fed had pumped in. One sign of this was an "exuberant and bubbling" stock market in which everybody said "this is a new era" in which the rules of the past no longer applied. The Fed, fearful that inflation was setting in, reduced money growth in 1928. Interest rates rose toward their market levels. Investments that had seemed profitable at lower interest rates were found to be unprofitable. Investment activity began to collapse. The stock market had its crash in October 1929.

Q. You say we had investment boom, low interest rates, stable consumer prices, a market boom and talk of a "new era." What does that suggest about the U.S. economy now?
A. I'm the rare economist who doesn't try to predict the future in a quantitative sense. No one has a crystal ball. I think a lot of economic forecasters are the late 20th century equivalent of the witch doctor who read the entrails of the goose, threw the bones, chewed on the peyote and looked through the smoke of the campfire to see visions of the future. I don't do that.

Q. Then what good is an economist?
A. As an economist, I explain the laws of supply and demand, competition and that like causes generally bring about like effects. History doesn't repeat itself, but we know that if we do the same wrong things we tend to have similarly wrong results.
I explain that prices like interest rates are meant to bring supply and demand into balance. If prices aren't allowed to do that, imbalances mount. I believe we have created a set of circumstances very similar to those generated by similar policies in the late 1920s.

Q. How big are the imbalances in your view?
A. Some analysts look at the stock market's price-to-earnings ratios and say that by any historical comparison they're way out of whack. I expected the correction to start last fall, when the market nose-dived. But the Federal Reserve got nervous and pumped more liquidity into the system. As a result, the money supply has risen rapidly. From February 1998 to February 1999, the money supply (measured by M3) grew over 10 percent. Some believe it should be 2 to 5 percent a year. I think it should be zero. By any standard, the Fed has been very inflationary. This is an artificial boom. There's a lot of real, healthy and desirable growth -- real innovation and globalization -- but laid over these positive developments is a manipulation of interest rates generating instability that will eventually drag down the economy. The Fed is allowing bad investments to accumulate and accumulate, constantly putting off the day of reckoning with one more burst of liquidity.

Q. Greenspan knows better, doesn't he?
A. I believe he has caught the bug of power. I think he believes that with his years as a private investment analyst and his success so far as Fed chairman, he can always bring the economy down to a soft landing. It's the arrogance and hubris of the social engineer.

Originally published
Datestamp: 05/02/1999, The Detroit News
Fed's role in economy is criticized: Manipulating vital interest rates wrong, Hillsdale prof says