According to Ogden Nash, “Too clever is dumb.” I’m not sure that’s true anymore. If so, it should curb the popularity of the Ben Ber-nak cartoon, but it feeds it instead. Too dumb has become clever.
The ridicule centers on the Fed printing money, which it literally doesn’t do, by the way, but try telling that to the millions of viewers.
For the record, when the Fed buys government securities in the market (yes, through dealers, of which Goldman Sachs is one), the ultimate seller gives up a highly liquid asset (government securities), which are not classified as money, for bank deposits, only slightly more liquid, which are classified as money. No wealth or pretend-wealth is created—no alchemy takes place. Yes, there is more of something called money put out there in exchange for something of equal value given up voluntarily by individuals or institutions who earned it in exchange for services in the marketplace. The amount of deposit money created matches the amount of government securities taken off the market if banks fail to make use of their new reserves resulting from their new deposits, which has been the case lately.
Now, if someone insists on calling that printing money, okay, but whatever it’s called, it is nothing new. It is nothing devious. It is what central banks do. It is how they conduct monetary policy. It has nothing special to do with quantitative easing. The only difference under quantitative easing is that the purchases probably focus on longer-term treasury securities rather than short-term treasury securities hoping to push longer term yields down a bit as well as get credit and money flowing again.
The point is this: It’s not new. It’s normal. The danger is not in the practice per se, but in the magnitude. Yes, inflation can result if it’s over done. But deflation can result if it’s under done. The challenge is to get the amount of money growth that results roughly in line with the capacity of the economy to grow in real terms—around 3-4 percent per year at full employment, somewhat faster at 9.6 percent unemployment.
The imagery of QE2—a huge ocean liner—is both misleading and unfortunate. If $600 billion is not needed by next June, then it want be used.
It’s bad enough when critics of the Fed get it wrong. It’s maddening when they get it exactly backwards. The Fed doesn’t go into the back room with the Treasury to swap pieces of paper or account balances because that practice has traditionally been viewed as subject to potential abuse. I used to call it monetary incest. To reduce that possibility, and the appearance of it, the Fed has traditionally conducted its open market operations at arms length from the Treasury—buying and selling outstanding securities from and to the market place rather than new issues directly from the Treasury itself.
Just as you and I would use a broker to conduct such transactions, the Fed does its buying and selling through pre-approved so-called primary broker-dealers. I believe there are 19 of them at last count. Yes, Virginia, Goldman Sachs is one of the 19. The transactions are done through an auction process with the dealers competing on price and the Fed accepting the low bids for buying and the high bids for selling. There is no sweetheart deal with “the Goldman” or anyone else.
Yes, the current president of the New York Fed is William Dudley, who served as Chief Economist for Goldman Sachs for 10 years before joining the New York Fed in 2007. I’ll bet he never dreamed he’d have to apologize for that distinction. No, Tim Geithner, his predecessor at the New York Fed, has never worked at Goldman Sachs despite persistent rumors to the contrary.
I tend to agree that actual deflation is a long shot, and that there may be certain special causes of deflation—namely rapidly rising productivity growth—that might make mild deflation benign. However, a blanket praise of deflation as a good thing and ridicule of those who worry about it is not benign. Is it so hard to understand that falling prices for some of us means falling incomes for others? It’s not like our paychecks stay the same as we get a windfall from lower and lower prices. Prices and incomes go down together and once that pattern becomes anticipated, deflationary psychology causes a destructive downward spiral of spending. Why buy today, when prices will be lower tomorrow?
I suppose we all can list specific items whose prices have risen over the past year while conveniently forgetting the prices that have fallen. But we do have official statistics on these things, price indexes weighted to reflect the importance of various items in our budgets. It is ironic, however, that one generally accepted measure of consumer prices—the core CPI—has just recorded, at plus six tenths of one percent, the lowest year-over-year increase in the history of the index.
I know I’m spitting into the wind. The cartoon is just too clever. We want to believe it. It makes us feel better to ridicule smart dedicated public servants like the Ben Bernak. I guess it makes the rest of us feel smarter. Maybe the mob will end the Fed and restore the gold standard. Then, a few years down the road we can ask how that’s working out for us.