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Missing the Boat on Monetary Easing


Even if by some miracle slashing interest rates did save jobs, the next question would be at what cost?


Nouriel Roubini is exploring why monetary policy easing is warranted even in the current insolvency crisis:

While aggressive monetary policy easing will not prevent a hard landing – as it did not prevent one in 2001 – the length and depth of an economic downturn is affected by monetary policy. And it is both the duty and responsibility of central banks to reduce partly avoidable severe economic downturn that lead to massive losses of jobs, welfare and incomes. The job of a central bank is not to bail out the financial system and/or investors but that of bailing out the real economy. Having millions of workers lose their jobs only to teach a lesson to reckless investors and lenders on Wall Street and the City does not make sense.

This is the most severe financial crisis that the global economy has experienced in the last few decades. But so far central banks have been deluding themselves that this is a temporary run-of-the-mill liquidity shock. It is time to recognize the severity of this crisis and take policy actions – that while unable to prevent now unavoidable and necessary massive financial losses and unable to prevent a US recession - that will minimize the extent of the collateral damage to the global economy of the reckless US economic policies of the last six years.

I have great respect for Nouriel Roubini. He has been proven correct about housing, about commercial real estate, and about the recession that is already upon us that most economists do not even see yet. His views on where things are headed are extremely close to mine and have been for as long as I can remember. I look to Roubini to see if I am on track with my own opinions about where we are headed and why.

Looking ahead, his views that the problem at hand is not a question of liquidity but a question of solvency are spot on. If he is wrong, then so am I. I have said the same things. I tip my hat to Nouriel Roubini.

Furthermore, there is no question a hard landing is coming. It will be the biggest hard landing since the Great Depression. Those are my words, not Roubini's, but that seems to be what he is projecting with the statement "central banks have been deluding themselves that this is a temporary run-of-the-mill liquidity shock."

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The problem I have is not in Roubini's analysis as to what is happening but rather in his proposed cure. Roubini alludes that the Central Bank is somehow in control of the jobs picture and jobs will be saved if only the Fed would aggressively cut rates.

I disagree. The Fed is not in control of much of anything, and certainly not jobs. Given the rampant overcapacity in darn near everything (see Implications of Commercial Real Estate Collapse), and given a housing bust we both seem to think is going to last for quite some time, I believe the Fed could slash rates to 0% and it will not create many jobs (at least not in the US).

The Seen and the Unseen and the Guesses

There is the seen and the unseen of slashing interest rates to save jobs. There is the seen and the unseen about what slashing interest rates would do about price inflation. There is the seen and the unseen about how our trade partners would react. There is the pure guess as to what might happen to long term interest rates if the Fed did what Roubini asked.

That is just the beginning of the seen and the unseen and the guesses. And oddly enough, there is not a person alive that can possibly say it would absolutely save any US jobs. Even if by some miracle slashing interest rates did save jobs, the next question would be at what cost?

Roubini and many others continue to place faith in the Fed's ability to do something intelligent while admitting the Fed's interest rate policy led us to the current path of destruction we are now on. This is not only missing the boat, but missing it big time.

The proposed cures are the same "cures" that got us to where we are today.

Greenspan attempting to prevent a hard landing in 2001 put off the problem to where we are today. Looking back at 2001-2002 there are only three possibilities as to what transpired.

  • The Fed is was guessing at what to do.
  • The Fed slashed interest rates to 1% hoping it would fix the problem, willing to take the chance no matter what the downstream consequences.
  • The Fed knowingly and willingly created a housing bubble for some naive if not outright devious purpose.

There simply are no other possibilities. And no matter which one of those you believe, there can be nothing but zero confidence in the Fed going forward. Bernanke and central bankers in general have a huge credibility issue now, and it is a credibility issue of their own making.

Sadly, not once have I seen Roubini say "The problem is the Fed. Therefore the Fed should be abolished." Instead I see a call for more intervention, more government regulation, and more of the same price-fixing interest rate "solution" that got us to where we are today.

The free market never would have let interest rates get to 1%, nor would the free market have let the ratings agent scam get as carried away as it did. For more on that subject please see Time To Break Up The Credit Rating Cartel.

More regulation is not the answer. More price-fixing interest rates is not the answer. More guessing about what to do is not the answer.

A Simple Solution With No Guesswork

  • Abolish the Fed.
  • Break up the credit rating cartel.
  • Eliminate fractional reserve lending (this cannot happen all at once but rather over time).
  • Put in place sound money policies based on a sound currency.

A currency backed by gold is the best sound money solution because a gold standard forces discipline. However, any solution that guarantees fiscal discipline could work, at least in theory. What we know for sure is the free market never in a million years would have come up with a scheme for currency that can be produced at no cost and backed by nothing, while pretending there is great value in it.

I pulled out my copy of The Monetary Elite vs. Gold's Honest Discipline for a quick review. I found these passages:

In 1970 80% of all money transactions were directly related to the production of goods and services. Five years later after the collapse of Bretton Woods, only 20% of all money transactions were directly related to the production of goods and services. In 1997, the figure was 1%.

If meaningful reform is not forthcoming, a financial crisis dwarfing all previous crisis is probably in the cards. One cannot know when this will occur but one can know why: the lack of scarcity and distributional integrity in the monetary unit.

Ironically, Roubini might be correct in that slashing interest rates is the right thing to do. After all, it is possible, even if extremely unlikely, the free market would opt for exactly his proposals. However, he is guessing just as the Fed is guessing. In simple terms, he does not know what the correct interest rate policy is. Nor do I, nor does anyone else.

If that was not bad enough, Roubini never really addresses the root cause of the problem. The root cause of this mess is government intervention into the free market. The free market boat would sort this out far better than price-fixing guessers and the free market, unlike price-fixing guessers, would change as conditions warranted. As right as he has been on everything else, Roubini simply missed the boat.


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