Price-fix­ing by the fed

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The fo­cus on whether the Fed­eral Reserve will raise in­ter­est rates raises a ques­tion no one thinks to ask: tion of in­ter­est rates, com­bined with the ex­ces­sive reg­u­la­tion of banks, has caused bank lend­ing to small and new busi­nesses to wither. Star­tups, es­sen­tial to job cre­ation and in­no­va­tion, are a frac­tion of what they should be. Work­ing cap­i­tal to fi­nance in­ven­to­ries has be­come less avail­able and, con­trary to the Fed’s mo­tives, more ex­pen­sive. Ditto the money for ex­pan­sions. Re­mem­ber, bonds are in­stru­ments for large, es­tab­lished busi­nesses, not for the ev­ery­day en­ter­prises and star­tups that are cru­cial to a well­func­tion­ing and ex­pand­ing econ­omy.

Whether it fully ap­pre­ci­ates it or not, the Fed­eral Reserve has gone into the busi­ness of credit al­lo­ca­tion. Un­cle Sam and large cor­po­ra­tions find credit all too easy and cheap to ob­tain, while the rest of the econ­omy suf­fers. Ap­ple has cash and fi­nan­cial in­stru­ments to­tal­ing more than $230 bil­lion, yet it has been is­su­ing tens of bil­lions of dol­lars in bonds to en­gage in fi­nan­cial en­gi­neer­ing, namely buy­ing its own stock and rais­ing its div­i­dend. Ear­lier this year Exxon Mo­bil sold $12 bil­lion in bonds for buy­backs, and other com­pa­nies have done the same for the pur­pose of pur­chas­ing their own eq­uity. And why not, when money is at vir­tu­ally give­away prices?

Noted economist David Mal­pass, a fierce and long­time critic of what the Fed and other cen­tral banks have been do­ing, has pointed out that the pro­por­tion of bonds to the U.S. econ­omy’s to­tal credit has surged from 39% a decade ago to 53% to­day. Man­i­festly, this isn’t healthy, as the global eco­nomic situation tes­ti­fies. The re­liance on cen­tral banks to gin up growth has al­lowed gov­ern­ments to avoid mak­ing badly needed struc­tural changes, such as cut­ting tax rates, re­duc­ing bloated public sec­tors, lib­er­al­iz­ing anti­growth la­bor laws and eas­ing suf­fo­cat­ing reg­u­la­tions.

Econ­o­mists will cry that in­ter­est rates are dif­fer­ent, that ma­nip­u­lat­ing the price of lend­ing money is es­sen­tial to guid­ing the econ­omy. Non­sense. Since when has such cen­tral plan­ning ever worked? Economies aren’t like an au­to­mo­bile whose speed can be reg­u­lated by an ac­cel­er­a­tor. By such logic the Fed should have the power to de­cree price re­duc­tions for ev­ery­thing: Cut all prices by 50%, and watch the econ­omy boom as peo­ple are thereby stim­u­lated to buy more stuff!

But isn’t cut­ting the cost of money a cru­cial tool for fight­ing re­ces­sions? No. Economies, if not hob­bled by struc­tural bar­ri­ers, will re­cover quickly enough on their own.

But what about the Great De­pres­sion? That catas­tro­phe wasn’t caused by some in­ex­pli­ca­ble fail­ure of free mar­kets but by dis­as­trous gov­ern­ment poli­cies, namely the collapse of global trade, which was trig­gered by the U.S.’ en­act­ment of the sweep­ing Smoot-haw­ley Tar­iff Act and the re­tal­ia­tory trade re­stric­tions of other na­tions that fol­lowed. The de­ba­cle was wors­ened by coun­tries re­spond­ing to the down­turn with mas­sive tax in­creases (the U.S. hiked its top in­come tax levy from 25% to 63% and boosted ex­cise taxes on an ar­ray of items such as movie tick­ets).

Be­fore the De­pres­sion cen­tral banks raised or low­ered the rates charged to banks that bor­rowed from them only to keep their cur­ren­cies fixed to gold.

The most con­struc­tive act the Fed could put in place would be to de­clare that at a date cer­tain—say, a few weeks from now—it would cease in­ter­est rate ma­nip­u­la­tion. Bor­row­ers and lenders alone would de­ter­mine the price of money. The only rate the Fed would set would be its dis­count rate—that is, the price it charges fi­nan­cial in­sti­tu­tions that wish to bor­row from it.

None of this, of course, would take away from the Fed­eral Reserve’s role as lender of last re­sort.

Free­ing in­ter­est rates from these cur­rent shack­les would ben­e­fi­cially im­pact to­day’s warped, ill-func­tion­ing credit mar­kets.

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