Price-fixing by the fed
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.