Popular convention purports that the Fed established its independence in 1951 when it told the Truman administration it would no longer fix a ceiling on government bond rates. The Treasury Department had to finance the Korean War and the administration expected all its agencies to fall in line. With the debacle of the Great Depression, and then the second error in 1937, still living memory, the US central bank had been reduced to a passive, largely technical role.
Even after 1951, however, the Fed was still just a second-rate influence. Nobody really took them serious as a matter of national policy because that was all being done by the Treasury Department. Capitalism had been declared the problem and the Great Depression all the necessary proof, thus there needed to be government guidance so as to not repeat the mistakes. The Federal Reserve, as all other central banks including the Bank of England, would be sidelined for decades in favor of that socialist “guiding hand.” Nowhere was this inflection more pronounced than in Great Britain.
In that respect, the British experience in the second age is quite emblematic of these marginal shifts. Churchill was a hero, a great man of all history, on May 8, 1945 (V-E Day) and out of office six weeks later; and not just barely, but in one of the most lopsided electoral shifts in democratic history. The Great Depression had shown the dangers of monetary overdrive, but not the relevant lessons taken from central command in instilling that impulse. Instead, economic thought roundly viewed the Great Depression as a systemic flaw of capitalism (socialists taking advantage of the opportunity), and if money wasn’t the answer then government and their treasuries was.
The central bank was to be made a tool of the state, and even though the Federal Reserve had forced Treasury’s hand in 1951 it didn’t really amount to much of a distinction; the Fed remained as such all the way into the perilous Great Inflation. Throughout the early years of that next debacle, in the late 1960’s, nobody took the Fed all that seriously especially when it came to the regular, laughable promises that the FOMC would constrain global consumer prices. As venerable and respected New York Times reporter Edwin Dale wrote in February 1969:
The Federal Reserve, it often seems, hurls thunderbolts and nothing happens. It raises the discount rate and it furiously buys and sells Treasury bills. It watches such arcane things as the Federal funds rate and net borrowed reserves and the bank credit proxy. It tells the world solemnly that, by golly, it means business in stopping inflation. It doesn’ t know how, to be sure. As King Lear said, ‘I will have such revenges on you that all the world shall– I will do such things–what they are yet I know not; but they shall be the terrors of the earth.
That passage can be read in the inverse as if written specifically for 2016, 2012, or 2009. It now more furiously buys and sells all Treasuries, and not just bills, and has conjured even more arcana with which to preoccupy its institutionalized tendencies; and all still for naught. Whereas the Fed promised to end inflation in 1969, when the Great Inflation was only just getting started, today it vows to create it. And like 1969, the Fed is a water pistol at a raging inferno. Mr. Dale’s article was appropriately titled Laughing At The Fed.
Then why do we (meaning “I”) spend so much time on them if in the end they don’t truly matter? The answer is Paul Volcker. Legend has it that he tamed inflation and saved the dollar, so greatly affecting expectations that markets were forced to pay permanent homage, especially after the recessions to start the 1980’s. If he could cause huge economic dislocations by the stroke of an FOMC vote, then what couldn’t he and the Fed do? It was a 180 degree transformation from what was largely believed about the central bank just a decade before. You laughed in 1969, but by 1979 you don’t even think about fighting them?
Out went the Keynesianism of the 1940’s – 1970’s and in came the monetarism of Milton Friedman, an activist central bank to fill in the power vacuum left as the Treasury Department, like Finance Ministries around the world. So thoroughly had they screwed up that they discredited the dogma sufficiently that the US Senate produced a distinctly bipartisan document that spit all over it. To many, this was the restoration of markets – but it wasn’t.
It was instead the reimposition of the illusion of control through other means; from WWI to WWII, monetary means. From WWII to the Great Inflation, fiscal means. The pendulum simply swung back in 1980. The question is whether Volcker had such a central role in “fixing” the problem, or whether that was just the natural flow of things; it’s not as if interest rates “needed” the Fed to go up, they were doing that already as interest rates tend to do during periods of unchecked money growth.
But even if Volcker was the hero, it doesn’t follow that the Fed had it all figured out. There should have been far more skepticism about activism as a general case rather than a specific case of 1979-81. Even if you believed Volcker’s Fed ended the Great Inflation that doesn’t necessarily mean the Fed can accomplish anything it wants. But nature abhors a vacuum, and in rushed the myth of the Fed as nearly omniscient whether it was or not. Because of the myth, everything that was positive was attributed to their skill, a doctrine cultivated by economics itself (enjoying fully all the prestige and power that went with it).
Anything negative was met with a shrug of the shoulders, as if it was just some mystery of the “markets.” When the S&L crisis struck, for example, Alan Greenspan was lauded for how he expertly handled the fallout instead of being grilled by a very interested oversight Congress who should have demanded answers as to why it happened in the first place. The myth of the Fed was and is that it fixes messes somebody else creates.
In other words, the rise of the wholesale money system had as much to do with both the S&L crisis as well as the limited damage from it. It caused thrifts to start acting like hedge funds, a “bank” model for which they weren’t at all suited, and then allowed banks that were perfect for it to fill the financial gap. Alan Greenspan avoided all the questions about the former, even though it was perfectly clear in almost all the official reports, so that he could take credit for the latter. He was no maestro; he was an accidental “genius”, a fact that has been proven throughout the 21st century so methodically that it is easily applied retroactively to his whole misunderstood reign (while still being enough left over to start raising questions about what Volcker really contributed).
His last major policy initiative was to “tighten” starting in June 2004. Though he did, the global economy didn’t, leaving his infamous “conundrum” to more aptly describe his tenure than anything else ever could. Inflation remained high, the eurodollar system raged, and the stage was set for a condition that in all likelihood should have been avoidable if not in some parts avoided.
So if the Fed is so powerless as to be perhaps irrelevant, then, again, why do we have to focus so much time and energy on it? The answer is the politics of its founding myth in this third age. Volcker still looms, as does Greenspan. It is bipartisan agreement that the Fed has the answers, and it has been that agreement this whole time. So long as that set of assumptions remains in effect, there can be no answers – the myth lingers that the Fed can fix whatever of somebody else’s mess. Thus, the Fed must be discredited in full first so that it can be discarded down to theory to get to the real problem, which is what they should have been doing all this time.
The Fed is responsible for the dollar by statute, yet it allowed the “dollar” to supplant it as the true global currency. The Fed was never in control, it merely conjured the illusion for it. That illusion is the biggest restraint on reform, as is perfectly clear when examining 2008 and its aftermath. Rather than bringing Ben Bernanke before Congress and demanding answers about how all that had just happened (and then watching the meltdown that would have transpired when it became perfectly clear he had none, a fact easily established by reading the 2008 FOMC transcripts and marveling at how these people ever came to be given such a vital task of global importance), he was given a medal (figuratively speaking) for his actions after it was over. He was lauded not for what he accomplished, rather for what he was supposed to accomplish where many, believing in the myth, just assumed that he would without any questions, or logic, or common sense intruding. In other words, the mainstream just accepted that Bernanke could be Volcker, if in the other direction, without ever re-examining the line of evidence from 2009 all the way back to 1979, and really 1969.
We have wasted seven years waiting for nothing, a likelihood that should have been established back then. Though the Fed is a joke, it is still politically potent, especially playing a key role in how even politics accepts what is actually wrong. Until it is fully humiliated, we are stuck in this limbo where we know exactly what is wrong but can’t do a damn thing about it. The whole thing is laughable, as I wrote here:
That leaves domestic monetary policy in the United States, of the world’s supposed reserve currency, as a process of fake reserves threatening highly indirect action in a market that nobody participates in. If that doesn’t sum up the economic predicament, than I doubt anything will ever do so.
If we are to truly parse what the Federal Reserve did last December, it truly makes perfect sense for truly absurd times. They targeted a monetary rate that nobody uses in order to project a story that nobody believes just so the media would write about an economic recovery that doesn’t exist. The Fed is truly a joke, and though it isn’t funny it is for now the only one we can tell. Until enough people hear it, we are stuck in only bad scenarios.