Foreword to Brendan Brown’s ‘A Global Monetary Plague’

Nothing else can or does create as much systemic financial risk as the Fed does by its monetary manipulations.  Since the dollar is the dominant international currency, the risk is created not only for Americans, but for people all over the world.  The scale of the current manipulation, or in Dr. Brown’s phrase, the “Great Monetary Experiment,” which the Fed is imposing on everyone, is unprecedented.  But there is nothing new in the Fed’s creating systemic risk, and blundering while it’s at it.  As the book relates in detail, this has been going on for nearly a century.  For example, the “powerful global asset price inflation” of the mid-1920s was “fueled by the monetary disequilibrium created by the Benjamin Strong Fed.”

The Ben Bernanke/Janet Yellen Fed of our day has explicitly sought to inflate bond, stock and real estate prices.  Other central banks, especially the European Central Bank and the Bank of Japan, have joined in, and a vast asset price inflation has indeed been achieved.  As one financial market observer has said, bonds internationally have surpassed “any known previous high of any recorded era,” and “every department of the credit markets is making all-time lows in yield.”  Dr. Brown reasonably characterizes this as yet another cycle of irrationality in asset prices stoked by monetary expansion—or more rhetorically, as a global, viral disease infecting financial markets.  What the final outcome of the Great Monetary Experiment will be is uncertain, but it certainly risks being ugly.

One of the most remarkable religious developments of modern times is the widely held faith in the Federal Reserve.  This odd faith results in many otherwise intelligent people, especially professional economists, ardently maintaining that the Fed should be an “independent” or virtually sovereign fiefdom, free to carry out without supervision from the Congress or anybody else whatever monetary experiments it wants.  But no part of a democratic government should be such an independent power.

The promoters of Fed independence, including of course the Fed itself, share a common, unspoken assumption: that the Fed is competent to have the unchecked power of manipulating money, or in a more grandiose version, of “managing the economy.”  It is assumed that the Fed knows what it is doing with its experiment of monetizing $1.7 trillion in real estate mortgages and $2.5 trillion in long-term government bonds, and blowing its balance sheet up to $4.5 trillion.  Dr. Brown maintains to the contrary that the Fed does not know what it is doing, that it is flying by the seat of the pants, and he works through a hundred years of financial history to show that it was ever thus.

Indeed, there is no evidence at all that the Fed has the special economic knowledge to make it competent to be entrusted with its enormous power, and a lot of evidence to show that it does not.  Believers in the Fed’s special competence are operating purely on a credo: “I believe in the Fed; I believe in a committee of economists manipulating money according to unreliable forecasts and debatable and changing theories from time to time in fashion.”

The Fed has no credentials to merit faith.  But the Fed is excellent, Dr. Brown shows, at causing financial instability while claiming to be promoting stability.  It is also excellent at allocating resources to big government spending.

An essential part of the Fed’s current theory, which has become a central banking fashion, is that central banks should create a perpetual inflation in goods and services prices.  Prices must increase forever, at a rate of 2% a year.  This means they will quintuple in a normal lifetime.  Under this theory, which Dr. Brown calls “deflation phobia,” average prices must never, never be allowed to decline, even if a period of marked innovation and accelerating productivity would lead them naturally to decline in a free market, thereby increasing real wages.  “No!” says the current Fed, “prices must be forced up to our 2% inflation target.”  Dr. Brown addresses at length how this doctrine of permanent inflation is perverse.

“Tell me one more time why we think 2% inflation is good,” as one financial writer recently demanded.  “When you lose 20% of your buying power in just 10 years, which span has included two deflationary recessions, the 2% inflation premise begins to look a little suspect.”  Indeed it does—and more than a little.

As part of the permanent inflation doctrine, the Fed has twisted the term “stable prices,” which the Congress has in statute instructed it to pursue.  The term has a clear and obvious meaning: prices that are stable.  As Dr. Brown points out, prices that are stable in the long run, sometimes go up and sometimes go down in the interim.  If they never go down, they cannot be stable in the long term.  Stuck with a Congressional assignment, but insisting that average prices can never go down, the Fed has a dilemma.  So it constantly claims that “stable prices” really means prices that always go up at 2% a year.

How did the Fed talk itself into that?  Consider the transcript of an informative meeting of its Open Market Committee in July, 1996, now publicly released, in which the committee discussed the issue of “long term inflation goals.”  “The most important argument” for perpetual inflation was that it allows “adjustments in relative pay in a world where individuals deeply dislike nominal pay cuts.”  In other words, its big advantage is that it fosters reductions in real wages.  This is the classic Keynesian argument for inflation sometimes, which the Fed has turned into inflation always.  The argument depends entirely on Money Illusion, which it was further argued, is “a very deep-rooted property of the human psyche”—a dubious proposition.  One lonely non-economist suggested the committee should consider what Congress meant by stable prices, but no one else took him up on that!  As the committee was meeting, the first of two great coming American bubbles was developing, but no one at all raised the question of asset price inflation.

Can monetary stability ever be achieved with such a Fed in charge?  Dr. Brown concludes that it is not only unlikely, but impossible: “It is not possible for monetary stability to emerge under a regime where the Federal Reserve is manipulating interest rates based on its ever changing views about the state of the economy and its supposed special knowledge.”  Without fundamental monetary reform, which means reform of the systemic risk-creating Federal Reserve, we have only “the bleak prospects of continuing instability.”

This book should be healthy intellectual therapy for Fed believers.  I hope it will prove so.