At the point our nation recognizes that the pattern of repeated bubbles, crashes, and misallocation of capital is not solved by the Fed but is instead caused by the Fed, it will become clearer that the best path to economic recovery is to shift attention toward debt restructuring, real investment, useful infrastructure, and the creativity and work ethic of real human beings. Until then, we will have an economy built on speculation and paper, stacked into a flimsy house of cards. As James Grant of Grant’s Interest Rate Observer noted last week, the Federal Reserve is presently run by “policymakers that seem to have no first, or fixed principles. Current monetary arrangements are defective and are robbing us of the dynamism this country has been known for… Somehow, with QE everything, with a zero percent funds rate, with monetary ‘mastery’ from the people in Washington, I think the current system is leeching dynamism from this economy and from society, and I think we’ll find something better.”
Grant accompanied those comments with an exceptional insight about the consequences of Fed actions – “Inflation is more than CPI – it is too much money chasing too few something or others. Inflation takes the form that we will know about later.” Speaking of the housing bubble, he observed “so the Fed was targeting inflation, as measured, but neglected to notice that house prices were where they had never been before. So that was inflation as it came to be defined in retrospect.”
That is exactly right. The policies that the Fed is pursuing here distort market signals, create speculative incentives, and encourage the misallocation of capital. There should be no doubt that this will damage our economic future over time, but we will only discover exactly the form of that damage later. The best vision for the United States is one where the markets allocate saving toward productive investments that legitimately have the potential to reward that saving, where the banking system finances good ideas and useful economic activity instead of looking for the next profit opportunity from financial engineering, and where government policies promote a flexible and well-trained labor market that is strong and skilled enough to enjoy a reasonable share of the economic fruits. That vision is only corrupted by the Federal Reserve’s misguided conceit that prosperity can be dropped from a helicopter, and by policies that avoid debt restructuring on the belief that lenders can never be allowed to suffer losses.