Who Needs the Fed?. John Tamny
hint about future policy direction, usually as it relates to prospective “easing” or “tightening” of credit in the marketplace. But in reality is credit being eased or tightened by the Fed, or by the marketplace? More fundamentally, can the federal government set the price of credit—defined broadly, not just in the fed funds rate—even if it wished to do so? Put another way, when we apply for a loan, are we basing our decision on the latest quarter-point move in the fed funds rate? Is the bank or other lender basing their rate on Fed policy? Tamny presents thought-provoking examples of credit transactions, ranging from Hollywood to Silicon Valley, from hedge fund managers to football coaches, that provide an iconoclastic perspective on the Fed’s effectiveness in doing that which it is purported, nearly unanimously, to do so well: managing the cost of capital.
Taking it a step further, Tamny asserts that, contrary to modern economic theory (but in line with common sense), the Fed’s actions potentially have the opposite of their intended effect. If the Fed is “easing” credit, it stands to reason that it is redirecting credit away from where the free market would have desired. If that is the case, then the attempted easing can lead to a suboptimal allocation of credit, which is to say, a suboptimal allocation of real resources. Is this strategy pro-growth? Hardly!
In the 1970s in the United States, with an electorate upset over the high price of gasoline, the government thought it sensible to give its citizenry a break by imposing wage and price controls. On the face of it, this seemed logical—paying less for gas would give drivers a break, spurring renewed economic growth with the money left in their pockets. However, price controls always have unintended consequences. In the 1970s that meant that in addition to the artificially low cost of filling your tank, you had to pay with your time, waiting in a daunting line of cars at the pump, hoping to get to the front of the line before the station was pumped dry. Worse still, once the gas station (whose revenues were artificially low as a result of being forced to sell its product below the market value) ran out of gas, they closed their doors to save on operating costs, thereby decreasing their employees’ income and further inciting panic at the sight of the closed doors. The increased panic made lines even longer, further increasing the price of the gas, as measured in time spent waiting in your car. So, exactly as common sense would suggest, price controls delivered economic contraction, not growth.
Credit has its price, just like gasoline. Seeking to control this price with easy credit is a futile endeavor at best; at worst, it can be a growth-destroying, resource-misallocating, and credit-tightening experiment in unintended consequences.
Tamny defines credit as access to real resources. He succinctly points out that the federal government has no credit of its own; rather, the fed is empowered to redirect credit—that it extracted from the private economy, through its ability to tax its citizens—namely, our credit. When the Fed seeks to stimulate the economy, by way of monetary policy, it renders the cost of carrying a national debt artificially low. However, as the Federal Reserve attempts to keep U.S. borrowing costs (and resulting deficits) down, it becomes an enabler of bad behavior, tacitly encouraging overspending, which drains the private sector economy that stands behind the nation’s credit. Exchanging lasting economic growth for a short-term discount on interest payments is a losing deal.
On the campaign trail in 2012, President Obama famously quipped “You didn’t build that” in reference to business owners who were helped along the way by government investment in infrastructure. His logic was that local, state, and federal governments educate the individuals who become the labor force, build the roads and bridges that our businesses rely on, keep us safe with military and police forces, and so forth. The irony is that the president had it backward. The government can’t spend without taking resources from the private economy first. The government didn’t build the roads; they were funded by taxes extracted from the private economy and built by private contractors (who fought through government agencies and a morass of red tape to do so) in locations that the free market deemed necessary. In addition, when these public works projects become a boondoggle, the amount of money spent on them by legislators tends only to go up.
Tamny correctly points out that money government wastes is gone; forget the notion of a Keynesian multiplier on wealth destruction. In the private sector, money and credit run from failure rather than being attracted to it. Real resources rarely lay idle. Left to their own devices, market forces would no doubt have built roads the way they have built cars, planes, shopping malls, and skyscrapers, but with less chance of building a bridge to nowhere. This point may seem tangential to the discussion of credit, but it is very relevant. Unless government is completely dysfunctional, its agencies don’t fully control where and how that infrastructure is built; rather, they attempt to react to market demands.
In much the same way, the Fed doesn’t fully control access to credit. Furthermore, just as state and federal legislators can misallocate resources and overinvest in marginal projects, dissipating national treasure, the Federal Reserve can distort credit markets by unintentionally misallocating the nation’s resources (credit equals goods and services!) by setting an artificial price for one swath of the credit market. In so doing, the Fed steers resources away from wherever the market would otherwise have sent them. Do the Fed’s monetary “price controls” successfully loosen our access to real resources? No. Do they create a drag on economic growth? Based on the somewhat startling observations in the following chapters, we can only conclude that price controls on credit cannot lead to economic prosperity.
Tamny’s conclusions are controversial. He suggests that the Fed is unnecessary and has the potential to do far more harm than good. He suggests that the protracted “zero interest rate policy” cannot possibly have helped to fuel the second-largest equity bull market in history. He suggests that artificially controlling the government’s cost of capital guarantees a misallocation of resources away from the private sector to the public sector, funding current public-sector spending at the expense of future growth. He also suggests (as does Milton Friedman) that deficits are irrelevant; what matters is the level of public-sector spending.
Readers may agree or disagree with each of Tamny’s conclusions. If we approach this important and highly readable book with a spirit of curiosity and a willingness to reexamine our beliefs, then we are guaranteed an intellectually stimulating adventure. Be prepared to reconsider your core assumptions about the nature of money and of credit.
A LENGTHY CHAPTER could be dedicated to thanking and acknowledging all the people who made Who Needs the Fed? possible. I’ll do my best to keep it somewhat brief, and declare from the outset that any errors of the factual or theoretical variety are mine.
Up front, Hall McAdams rates very special thanks. I first visited with him in 2003, and since then he’s become a very important—and patient—friend. An expert on banking and free market economics, Hall has been pushing my buttons about banking, credit, and the Fed for years. His skepticism about conventional thought on all three nourished my own thinking in a major way. Absent Hall there would be no book, simply because our regular communication opened my eyes to the ideas that led me to write it. Hall’s wonderful wife, Letty, similarly deserves mention for encouraging the constant communication between Hall and me.
Hall’s teachings piqued my interest in finance and ultimately led me to books on banking by Robert H. Smith. Ironically Smith lives on the same street as my parents. This requires mention mainly because name recognition led to conversations and e-mails with Smith that provided me with essential information and insights that, in turn, gave life to Who Needs the Fed? Absent Smith, what I presume to be good about this book would be substantially neutered.
Arguably the toughest part of writing any book is putting pen to paper for the initial chapters. In this regard, Jessica Disch requires significant mention for attending a Taylor Swift concert with my wife, Kendall, and for documenting the “surge pricing” offered by Uber in the concert’s aftermath. Jessica’s happy experience provided real-world evidence that the Fed’s frequent pursuit of “easy credit” is wholly backward.
Big thanks go to Ralph Benko for being such an interested reader in what most would agree is