CATO Questions the Fed

Don’t worry, Koch brothers; no one stepped out of line…

In a commentary entitled “Bernanke’s Monetary Mess,” Steve Hanke dissects Ben Bernanke’s performance during his tenure at the Federal Reserve:

Most who have graded Prof. Ben Bernanke’s twelve years at the Federal Reserve have issued marks which range from A to a gentleman’s C. I think those marks are much too generous. Indeed, I think a failing mark would be more appropriate.

How Mr. Hanke comes to this conclusion, I will get to shortly.  First, who is Steve Hanke?

Steve H. Hanke is a Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University in Baltimore. He is a Senior Fellow and Director of the Troubled Currencies Project at the Cato Institute in Washington, D.C.; a Senior Advisor at the Renmin University of China’s International Monetary Research Institute in Beijing; a Special Counselor to the Center for Financial Stability in New York; and a contributing editor at Globe Asia Magazine. Prof. Hanke is also a member of the Charter Council of the Society of Economic Measurement and the Financial Advisory Council of the United Arab Emirates.

In the past, Prof. Hanke taught economics at the Colorado School of Mines and the University of California, Berkeley. He served as a Member of the Governor’s Council of Economic Advisers in Maryland in 1976-77; as a Senior Economist on President Reagan’s Council of Economic Advisers in 1981-82; and as a Senior Advisor to the Joint Economic Committee of the U.S. Congress in 1984-88. Prof. Hanke also served as a State Counselor to both the Republic of Lithuania in 1994-96 and the Republic of Montenegro in 1999-2003. He was also an Advisor to the Presidents of Bulgaria in 1997-2002, Venezuela in 1995-96, and Indonesia in 1998. He played an important role in establishing new currency regimes in Argentina, Estonia, Bulgaria, Bosnia-Herzegovina, Ecuador, Lithuania, and Montenegro. Prof. Hanke has also advised the governments of many other countries, including Albania, Kazakhstan, and Yugoslavia.

Sorry for the long biography, but I think it is worthwhile to consider the background of the analysts utilized by the Cato Institute.  These are policy wonks, advisors to central banks and governments throughout the world.  Now I know there are countless thousands of such individuals; sadly, too many are associated with an organization supposedly devoted to liberty:

The Cato Institute is a public policy research organization — a think tank – dedicated to the principles of individual liberty, limited government, free markets and peace.

Now, on to Hanke’s analysis; he starts with a little macro-economic jargon, suggesting the tone of any upcoming criticism (emphasis added in all cited passages):

Bernanke and the Fed created a classic aggregate demand bubble…when final sales to domestic purchasers…surge well above the trend rate of growth consistent with modest inflation.

Terms that cannot be measured in any meaningful way – in other words, par for the macro-economic course.

Consistent with his biography, and the actual bent of this institute supposedly dedicated to individual liberty and free markets, Hanke offers a criticism of the actions of the Fed while never once questioning the existence of the institution:

The pre-2008 crisis bubble was set off by the Fed’s liquidity injections which were initially designed to fend off a false deflation scare in late 2002.

To fight the alleged deflation threat, the Fed pushed interest rates down sharply. By July 2003, the Fed funds rate was at a then-record low of 1 percent, where it stayed for a year. This artificially low interest rate — compared to the natural or neutral rate at that time, in the 3-4 percent range…

How does Hanke or any economist – presume to know the “natural rate”?  No one can know beforehand the rate of interest in a market left relatively free.  Anyone claiming to be bright enough to know this should make a killing investing in markets.

The problem, according to Hanke, is not the institution of central banking but only that the Fed needs better economists:

But, as the late Prof. Gottfried Haberler emphasized in 1928, "the relative position and change of different groups of prices are not revealed, but are hidden and submerged in a general [price] index". Unbeknownst to the Fed, abrupt shifts in major relative prices were underfoot. For any economist worth his salt, these relative price changes should have set off alarm bells.

Bernanke, apparently, just wasn’t looking at the right metrics:

While operating under a regime of inflation targeting and a floating U.S. dollar exchange rate, Chairman Bernanke also saw fit to ignore fluctuations in the value of the dollar.  Indeed, changes in the dollar’s exchange value did not appear as one of the six metrics on "Bernanke’s Dashboard"—the one the chairman used to gauge the appropriateness of monetary policy.

Six metrics.  Six…. Presumably Hanke would be satisfied if Bernanke had seven metrics?

In addition to not displaying the dollar’s exchange rate, Chairman Bernanke’s Dashboard didn’t concern itself with money-supply gauges.

OK, eight metrics.  That will do it according to Hanke.

Six, sixty, six-hundred, six-thousand, six-million.  There is no number of metrics that will allow one man or one group of economists to figure out the proper price and quantity of money and credit.  To suggest otherwise, as Hanke does, certainly perpetuates the desired narrative for all political institutions: the institution is necessary, we just need to find better people.

…the annual inflation rate measured by the Consumer Price Index plunged from 5.6% in July 2008 to -2.1% in July 2009. With the demand for greenbacks and safe assets (read: U.S. Treasuries) soaring, the Fed was way too tight and didn’t even know it.

Presumably the Consumer Price Index is actually on “Bernanke’s Dashboard.”  He missed it anyway.  I guess a better economist would have seen it?

It isn’t that Hanke is unaware of an Austrian view:

Indeed, sharp changes in relative prices are a signal that, under the deceptively smooth surface of a general price index of stable prices, basic maladjustments are probably occurring. And it is these maladjustments that, according to Haberler, hold the key to Austrian business cycle theory — and, I would add, a key to understanding the current crisis.

Artificial credit-created investment booms sow the seeds of their own destruction. With the Fed funds rate well below the natural rate in 2003, a credit boom was off and running. And as night follows day, a bust was just around the corner.

Hanke goes on to point out the dramatic price increases in homes, stock markets, and commodities in the period up to 2008.  These increases should have been noticed by economists at the Fed, and would have been noticed if the Fed employed better economists – “any economist worth his salt.”

Hanke ends with his criticisms of current policies – perhaps he is one of the salty economists needed at the Fed:

…the Bank for International Settlements in Basel, Switzerland (the central bankers’ bank) has issued new Basel III capital rules that will bump up banks’ capital requirements. And if that isn’t bad enough, the Fed has embraced many new regulations contained in the Dodd-Frank legislation. All this regulatory zeal has created a credit crunch. This has resulted in a damaging pro-cyclical policy stance in the middle of a slump — just what we don’t need.

Concluding with a sentence that could be written for virtually every single endeavor of central planning:

Prof. Bernanke’s days at the Fed have been marked by monetary misjudgments and malfeasance.

Bernanke saved the large money-center banks.  He ensured the continued transfer of wealth from the productive to the non-productive.  He did his job very well.  Hanke is wrong – for those for whom Bernanke works, he earned much better than “a gentleman’s C.”  For those that count, Bernanke has earned an A+.

Hanke delivers one more pathetic piece from an institute supposedly dedicated to individual liberty and free markets.  Not one word of questioning the central planning of money. 

His solution?  If only we had better economists with better dashboards.

There is only one solution.

End the Fed.