The Magazine

It’s the Money, Stupid

Papering over our economic problems.

Oct 18, 2010, Vol. 16, No. 05 • By JEFFREY BELL and SEAN FIELER
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It’s not that no one has noticed the policy shipwreck. But Bernanke has remained immune to criticism even from conservative inflation hawks because they can’t articulate what they would have done differently. Substantive criticism needs to extend beyond Bernanke and dissect the nature of the paper monetary system. Conservatives’ inability to offer a systemic critique, despite the fact that the paper standard is in the process of breaking down, shows the extent to which the right has been coopted by the idea that the monetary authorities should micromanage the economy. 

In a sense this is not surprising, since it was the iconic Milton Friedman who helped convince Richard Nixon to suspend gold convertibility and float the dollar on August 15, 1971, leaving the Fed with full discretion to intervene in the economy to smooth out business cycles. Friedman deserves enormous credit for bringing the conservative movement and even many nonconservatives to embrace free-market theory, especially deregulation, at a time when it wasn’t in vogue. But unfortunately his long shadow extends to include his quasi-Keynesian belief that the Fed should engage in economic planning. 

The awkward truth is that conservatives have grown to rely on the Fed to right the economy in a recession. After all, monetary fine-tuning can soften the blows of economic turbulence. For two decades, Republicans cheered on one of their own, Alan Greenspan, in this endeavor. President George H.W. Bush even begged Greenspan (unsuccessfully) to further cut interest rates as the economy pulled out of the 1990-91 recession.

But this dependence on monetary policy to smooth out the business cycle has proven short-sighted. Easing the downside of recessions comes with a huge cost—the pileup of debt, which opens the door to riskier financial behavior and more traumatic crises. Consider the year Hoenig singled out, 2003, when the Fed brought the Fed funds rate down to 1 percent on its exaggerated fear of deflation. The housing bubble that grew out of this easy-money policy burst with consequences no one from Greenspan on down ever imagined. And the Fed is still trying to figure out how the economy will emerge from that catastrophe. 

Unfortunately for would-be incrementalists, there is no viable way to maintain the Fed’s current role as guarantor of short-term financial stability and still reform the paper money system so as to remove its tendency toward the unsustainable accumulation of debt. For the paper money system that the Fed manages not only encourages debt, the system is debt. A newly issued dollar is in fact a form of government-issued debt whose only value comes from its mandated ability to pay off existing dollar-denominated debts. In this system, more debt will always be the painless short-term cure for the general problem of overindebtedness, even though more debt is an insane long-run response to the problem of too much debt. 

The self-perpetuating feature that has kept this perverse system alive is the dollar’s position as the world’s reserve currency. Before the dollar assumed this role between the two world wars, gold—something of independent value and no particular country’s liability—was used to settle international payments between central banks and composed their primary reserve asset. But with the dollar performing those functions, its oversupply has often been absorbed abroad. So Bernanke and his predecessors in the paper-dollar era have been able to print a lot of new dollars, over time inevitably driving down the global value of the dollar, without necessarily generating domestic inflation. That is the enabler of, among other things, relatively painless federal budget deficits. For a red-ink-hemorrhaging Greece or California, the specter of default is always on or near the table. For Bernanke and Congress, colossal deficits are just another day at the office.

Republicans, far from broaching this unwelcome subject, have correctly concluded they need say little new to achieve a huge comeback in Congress, given the electorate’s mounting dislike of Obama’s European-style paternalistic elitism. The challenge (and danger) for Republicans will come after the November election, particularly if they regain control of one or both houses of Congress and find themselves in need of a legislative agenda to send, or attempt to send, to the desk of President Obama for his signature or veto. 

By focusing solely on fiscal policy Republicans are setting themselves an impossible task. They don’t seem to have grasped the extent to which our debt-driven monetary system enables (and therefore encourages) irresponsible fiscal policy. As was true under President George W. Bush, Republicans will be operating in a monetary environment that precludes the possibility that the federal government can ever run out of money to spend, which makes it virtually impossible to control spending. 

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