"Monetary' and 'Fiscal' Policies: A Unholy Alliance

The Federal Reserve's latest move - buying a trillion or so dollars worth of long-term paper from the U.S. Department of the Treasury and purchasing worthless mortgage securities from Fannie and Freddie - has stirred the hearts of cranks everywhere. Economists and the media have called it a "bold move," as though revving up the printing presses to crank out worthless dollars takes bravery.

Yet, there really is method to the Fed's madness, although that method is like the miracle worker turning the blind man into the blind man who also is lame. The stated purpose of this policy is to "thaw" the "frozen" credit markets, and especially to reflate the housing bubble, giving new meaning to the satire that appeared in The Onion last year:

WASHINGTON - A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.

"What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."

Yet, the Fed and the Treasury are tag-teaming not just to increase the amount of business and home lending, but also to pull off that unholy matrimony between so-called fiscal and monetary policies. According to Keynesian doctrines, the economy might be caught in a "liquidity trap" in which central bank policies might create new bank reserves, but the opportunities for actual lending by banks either are few or are plagued with uncertainty, thus keeping the new money from actually moving into the economy. Thus, the recent actions by the Fed (lowering its lending rates to about zero percent) really don't "stimulate" any new economic action.

Keynes (and his followers, such as Paul Krugman) argue that when the economy is in a "liquidity trap," the only effective means of economic "stimulus" is for government to spend directly on things like public works or other activities that directly put money into the hands of individuals (who had better spend it - or else). However, in order for the government to find new revenues, it must resort either to raising taxes or borrowing, or a combination of the two.

Such actions, of course, have their own consequences. Raising taxes in an economic downturn can make the downturn worse (although Keynesians then trot out their infamous "balanced-budget multiplier" that "proves" that government spending is better for the economy than private spending), and there are real limits to borrowing. What's a government to do when faced with these limitations? It is Ben Bernanke to the rescue, as he has devised a plan to do an end run around the "liquidity trap" and to give the Treasury new money for its "stimulus."

Traditionally, the Fed has limited its securities purchases to government bonds, but bonds that are bought and sold in secondary markets. That means others, be they institutions, individuals, or even other governments, must first have bought the government bonds before the Fed can purchase them. However, what happens when the seller runs out of suckers, that is, when U.S. Government bonds no longer are seen as a worthy investment or that there simply are not enough sellers to satisfy the huge demands of the U.S. Treasury?

Thus, it is Bernanke to the rescue. No longer is the Fed going to have to be constrained to purchasing government bonds in the secondary markets, and then leaving the payments in bank reserves where they might sit because of the dearth of new investment opportunities. Instead, the Federal Reserve has decided to purchase private equities, Fannie and Freddie mortgage securities, and last, but not least, long-term Treasury bonds, the last being a primary market transaction.

This last move is significant because it unleashes the Fed from former limitations to create new money. At the same time, the Treasury no longer is constrained by limitations of taxation and limited incomes of individuals and institutions that traditionally have purchased new government bonds. Instead, the Treasury sells its bonds directly to the Fed, which then credits the Treasury ledgers with new money. The government then spends as it pleases.

Call it Bernanke's "controlled helicopter drop." (At least, we know where this money is going, as some of the money falling from Ben's helicopter might fall into lakes, rivers, and mountaintops, never to be spent, or, worse, hoarded by nervous consumers or - even worse - used to purchase gold.)

Such a move by the Fed - which many of us have been predicting for a while - thus permits the "marriage" of fiscal and monetary policies, something that even Krugman and Keynes might appreciate. There no longer is the need to depend upon bank executives who might insist on having their loans repaid or who might use some of that money to pay themselves bonuses (or give to Barney Frank and Christopher Dodd in the name of cheap mortgages or campaign contributions).

Although economists are cheering this latest development, the Austrians know better. There is no way the economy can absorb this amount of new money without severe malinvestments and dislocation of the economic fundamentals, and that simply sets the stage for later and more virulent crises.

Ironically, the Fed is creating the foundations of new crises even while it supposedly is acting to address the current Fed-created crisis. Whatever rallies might be seen in the markets due to this latest Fed outrage are going to dissipate once it becomes clear that what the Fed has done to the Humpty-Dumpty of our economy is to take the sledge hammer to poor Humpty, all in the name of putting him back together. By trying to put off the day of reckoning, Ben Bernanke is making sure that Judgment Day will be worse than it would have been had he just taken a long vacation when the markets sounded their first warnings.

William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute. He also is a consultant with American Economic Services.

Copyright � 2009 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit is given.

Your Daily Looneytunery

Submitted by sniffles5 on Fri, 03/20/2009 - 1:46pm.

I was beginning to get worried....almost 3 p.m. and no LIbErtarian cut-and-paste from Darth Looneytunes.

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