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FINANCE
THE US FEDERAL RESERVE
The corrupt arithmetic of the Federal Reserve ... A special privilege afforded to banks is negatively impacting the functions of the Federal Reserve
THE US FEDERAL RESERVE
The corrupt arithmetic of the Federal Reserve ... A special privilege afforded to banks is negatively impacting the functions of the Federal Reserve
Original article: http://www.aljazeera.com/indepth/opinion/2011/09/20119811275624854.html
Peter Burgess COMMENTARY
This commentary is being written in June 2022, a decade after this article was originally penned.
The Federal Reserve always gets a mention on the evening news when it makes any sort of pronouncement, but it is rare for the media to go into any depth about what the Federal Reserve is all about and how it works. Hardly anyone in the general public knows anything about the functioning of the Federal Reservce and the way it works.
This article helps ... but maybe not as much as it should. This is no surprise because it is fairly clear that there is little consensus among economists about what Fed policy should be.
I have been concerned about what I call the 'financialization' of economic activity in the last many years since around 1980. Everything seemed to 'fall apart' in the late 1960s and the 1970s, but then started to 'come together' again in the 1980s. My view is that this was accomplished by making economic numbers look good while social numbers ... quality of life ... was degrading for the majority of the population.
The current Fed Chairman is Jerome Powell. He often repeats that the Fed goal is to have full employment and stable prices. I don't find this particularly helpful because it is such a huge simplification and ignores many characteristics of the modern economy that determine things like quality of life.
One of the things that is of interest to me is the profitability of the economy. This is very different from prices in the economy. A private business cannot survive without some level of profit, and flourishes when there are high profits ... the higher the better.
One of the key characteristics of the 1970s was that the cost of doing business went up dramatically. The main cause of this was the 1973 'OPEC oil shock' when the international price of crude oil went up from $3.50 a barrel to $13.50 a barrel. This was orchestrated by the oil minister of Saudi Arabia and changed everything. At the time, I wrote that this was the biggest economic event in all of history ... and I have no reason to question that judgement almost 50 years later. By the end of the 1970s, the price of crude oil had climbed to around $30.00 a barrel.
The fact that the OPEC cartel was able to succeed and become the controller of the price of oil in the global market needs to be explained. My view is that it was allowed ... indeed desired ... by many of the big actors in the energy sector. All the big international integrated oil companies ... Esso, Shell, BP, Chevron, Mobil, Total, etc.... were happy to see higher prices for crude oil. For them it enabled higher prices in the market place for gasoline and higher profit margins. Several countries that were not part of OPEC (Organization of Petroleum Exporting Countries) including the UK and the Netherlands were not unhappy with OPEC's move. Several countries had invested heavily in development of 'offshore oil fields' including in the North Sea and the Gulf of Mexico and this oil had a much higher cost than the prevailing $3.50 a barrel price ... probably nearer $13.00 a barrel.
And there was also another element in all of this. Walter Wriston, the Chairman of CitiBank got OPEC's agreement for international oil contracts to be denominated in US dollars, a move that put American banking at the center of this potentially highly profitable international industry.
The Federal Reserve proved to be completely impotent as a controller of inflation in the 1970s. Even though interest rates were set at around 20%, it did nothing to curb the 'cost-push' inflation of the era. Rather it merely added another cost to the already high costs of doing business caused by the energy cost increases, and everything produced using energy.
It was not until the 1980s that countries like the USA got to get to a lower cost of goods to enable higher profits. This had several parts. One was to shutter US manufacturing in high labor cost areas of the country and relocate to lower cost non-Union areas mainly in the South. Another was to completely outsource production to low cost parts of the world like Japan, China and other countries in Asia. Business became profitable once again, but most US workers lost wages and benefits. Wages and benefits for workers have 'flat-lined' since the 1980s while business producivity and profits have increased substantially ... probably as much as 400% over 40 years.
An important secondary element is that banks facilitates a continuance of a high level of consumption in the American economy by easing credit rules ... both for consumer loans and for house mortgages. This aggravated the financial situation for American workers and resulted in a series of financial disruptions ... the Savings and Loan crisis in the late 1980s and the Great Recession of 2008/2009. In each case, banks lost little, but many of their customers lost everything.
Sometimes the Fed does the right thing ... but I am not sure that they understand the totality of the workings of the socio-enviro-economic system very well. Much of the chatter in Congress about economic intervention is strictly about political talking points most of which might have made sense in the 1820s but not so much 200 years later, especially from rich right wing conservatives. Modern political decision making is not helped much by clumsy government accounting and the archaic analysis of the Congressional Budget Office both of which do far too little to differentiate between Government spending on capital investment and all the other expenditures of government.
Peter Burgess
There is reason to believe that the first two rounds of quantative easing has some positive effect [EPA]
Written by Dean Baker ... Dean Baker is a US macroeconomist and co-founder of the Centre for Economic and Policy Research.
Last Modified: 09 Sep 2011 08:26
Last month the Federal Reserve Board’s Open Market Committee (FOMC) voted 7 to 3 to commit itself to keep its short-term interest rate at near zero for the next two years. Given the persistence and severity of the downturn this was a modest step for the Fed to take to boost the economy.
There were several more aggressive actions that the Fed could have taken. For example, the Fed could have targeted a longer term interest rate. This could mean something like setting a 1.0 per cent interest rate target for 5-year Treasury bonds over the next year. Such a policy could be expected to drive down borrowing costs throughout the economy. That would lead to more mortgage refinancing and some additional investment.
Lower interest rates would likely also lead to a somewhat lower value of the dollar. This would make imports more expensive and make our exports cheaper to people living in other countries. That should help to reduce our trade deficit, the most important imbalance facing the economy.
The Fed could have also been even more aggressive and followed a path suggested by Ben Bernanke for Japan’s central bank back when he was still a professor at Princeton. Bernanke recommended that Japan’s central bank deliberately target a higher inflation rate in the range of 3-4 per cent. This would have the effect of reducing real interest rates when short-term nominal rates are already at zero. It would also reduce the burden of debtors.
Alternatively, the Fed could have just done more of the same. It could have followed up its second round of quantitative easing (QE), with another round of bond buying. The idea is to push up the price of Treasury bonds and thereby lower interest rates. While there is some dispute about the impact of the prior two rounds of QE, there is reason to believe that they had at least some positive effect.
However, the three dissenters did not want the Fed to pursue any of these paths. They were uncomfortable even with a statement that the Fed would continue to keep its short-term rate near zero. This is in spite of the fact that the unemployment rate remains over 9.0 per cent and growth has averaged less than 1.0 per cent over the last 6 months.
The dissenters were worried about inflation. The concern about inflation seems positively bizarre for an economy with such high unemployment and so much excess capacity. Workers have almost no bargaining power. They are lucky if their wages just keep pace with inflation; they have little hope of wage increases that are in line with productivity growth.
The core inflation rate continues to hover just under 2.0 per cent. It has remained pretty much constant since the start of the downturn.
The inflation hawks can point to a rise in the overall rate of inflation, but this was driven by surges in food and energy prices. These were in turn partially attributable to speculation and partly due to rapid growth in China and other developing countries. The speculative part of this run-up looks like it is being reversed as some commodity prices, most notably oil, have fallen sharply in recent months. The Fed really can’t hope to do much about rises in commodity prices that are driven by rapid growth in the developing world.
This raises the question of why the hawks are so concerned about a seemingly non-existent inflation threat. It is worth noting that all three of the dissenting votes were Fed district bank presidents. The presidents of the Fed’s 12 district banks all sit on the FOMC, with five of them voting at any one time. Three of the five bank presidents voted against any action to spur growth.
The bank presidents essentially represent the banks within their district. Banks tend to be very concerned about inflation since it erodes the value of their loans. They tend to be less concerned about unemployment, probably because the bankers have jobs, as do most of their friends.
While the bank presidents voted three to two against taking any action to boost the economy, the five governors voted unanimously in support of the statement committing the Fed to keep its short-term rate at zero for the next two years. In contrast to the bank presidents, the governors are appointed through the political process. Interestingly there was no partisan divide on this vote. Three of the governors were appointed by President Obama, one by President Bush, and one (Chairman Bernanke) by both. Yet all five felt that the Fed’s mandate to promote full employment required stronger action.
The sharp split between the FOMC members appointed by the banks and the members appointed through the political process is very disturbing. It suggests that the financial industry is using an agency of the government (the Fed) to advance its own interests.
While industry capture is a problem with all regulatory bodies, in no other case does the industry directly appoint members to the body. Comcast and General Electric have to lobby the Federal Communications Commission (FCC); they don’t get their own votes on the FCC.
There is no reason that the banks should get the special privilege of being assigned seats on the Fed, the most powerful regulatory agency of them all. There is no place in a democracy for the bankers’ direct role in setting Fed policy. The banks should have to buy their influence just like everyone else.
Dean Baker is co-director of the Center for Economic and Policy Research in Washington, DC.
The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera's editorial policy.
Source: Al Jazeera