Too Dumb is Clever

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.

Comments (9)

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  1. Erosen says:

    Please explain why James Grant also calls it printing money, as does Forbes. These are not dumb people. Thank you for the informative post.
    A better title might have been A more balanced perspective on money printing. Agree with your point that it is the amount printed that makes the difference.

  2. Namazu says:

    According to the economist Yogi Berra, “In theory there is no difference between theory and practice. In practice there is.” You may decide whether this observation is clever or dumb. Many observers who are neither clever nor dumb have been making precisely this point with regard to the Fed’s highly-leaked new program which now bears a moniker you don’t like. Now a man’s blog is his castle, but if you insist on debating two cartoon bears, please recall that Mr. Bernanke admitted to “money printing” on national television (can we agree to call it argot?) and that other former Fed officials are on record saying the message of the cartoon is essentially correct. Finally, while I know it must be painful to see one’s institution and colleagues criticized, I find your use of the word “mob” regrettable. While I certainly wouldn’t invite a member of Congress home to dinner, the public has few defenses against an institution that whose reach increasingly exceeds its intellectual grasp and its legal mandate. And if you must summon the specter of a deflationary gold standard, remember that we’ve already been threatened with tanks on the streets.

  3. mortgagedrone says:

    Interesting viewpoint, but I think there is a missed step in your logic. The printing of the money doesn’t occur as the bonds are sold, it occurs when the interest is paid and/or the principal is returned at maturity. In my mind it is no different from the “liar loans” that contributed to the housing bubble and subsequent crisis. A borrower, private or government, can borrow as much money as the market will give them, but if a private borrower doesn’t have the assets or income to repay the borrowings it results in bankruptcy. But when the government has excessive spending and creates deficits as we are currently experiencing, there is one solution – printing money.And maybe I slept through too many high school civics classes, but doesn’t the Fed manage the paper currency supply by printing dollar bills? If they are printing more than they are retiring from circulation, they are devaluing the existing currency – hence the concern that QE II will have a significant future impact on inflation levels and the economy. I am not sure why this concern is so hard for Fed defenders to understand.

  4. Joe says:

    Where does the Federal Reserve get the money to fund its operations?
    The Federal Reserve’s income is derived primarily from the interest on U.S. government securities that it has acquired through open market operations.
    (http://www.frbsf.org/education/activities/drecon/answerxml.cfm?selectedurl=/2006/0605.html)

    There seems to me to be a circularity of income that I just can’t quite understand. The Fed buys government securities with income derived from interest on government securities? It just doesn’t make sense…

    If the Fed has trillions of dollars in assets to start with, where did it come from? How much does it really have? Where is it? It sure seems like it just creates an account and makes up the number of dollars it needs and then buys whatever it needs. Am I wrong?

  5. Bob Reich says:

    I suppose this former colleague of Mr. McTeer’s didn’t know what he was talking about either. (We’ll never know. Because he never responds to ‘reader comments’. We’re too dumb apparently.)

  6. Ivan Grazhdanin says:

    I once attended a serious seminar that featured the founder of PayPal who strenuously–no other word for his passion–predicted the end of paper money; the future, of course, was all plastics (excusing Benjamin Braddock for the moment). So why do otherwise bright people, especially politicians and Ph.D. economists with a political agenda, bash the Fed. Quite simply because it gets them on talk radio and the cable TV news programs. Sometimes it even wins elections.

  7. Devon Herrick says:

    Research dating back decades has illustrated how the boom and bust business cycle periodically experienced for more than a century substantially lessened once the Fed began to manage the money supply.

  8. bill says:

    How can you or the Ber-nank talk about “deflation” with a straight face when Gold is at 1400 an ounce and oil is a $90 a barrel??? Gold has been soaring ever since the Ber-nank was appointed because the market knows he is a serial bailer who never saw an asset bubble he didn’t love. So, the Wall St. speculators get rich of his never ending bubble/crash policies while the middle class get wiped out. Since this wonderful QE2 policy was announced the prices of the things Main St. needs to survive (food, energy) have skyrocketed, and mortgage rates have gone up. How exactly is that helping the average person? Answer: It isn’t. But it is helping Wall St. to have more record bonuses and that is all the Ber-nank cares about, the banksters like Goldman are his masters. The little guy will get no benefits out of this economic Frankenstein experiment, but will get stuck with the tax bill to bail out the speculators when all these massive QE2 induced asset bubbles burst. The only hope we have is that Ron Paul can put a stop to this insanity!

  9. Kyle says:

    “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…

    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 words you wrote above evidence the fact that you are either a financial imbecile or a blatant liar.

    The FED created this crisis, the banks gamed the system and pawned the loss off on the taxpayers after threatening Congress of an apocalyptic collapse with the ever popular “tanks in the streets” tactic. If you morons think we’re going to forget this, you’ve got another thing coming.