Wednesday, May 2, 2012

Limited Hope

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

Frederick Sheehan will speak at the Committee for Monetary Research and Education (CMRE) dinner on Thursday, May 17, 2012. It will be held at The Union League Club in New York. He will discuss "How We Got Here."

            Presidential election campaigns are a source for speculation. How would life change in a second Obama term or with a Romney victory? The economy and the financial markets will be discussed as a single topic.

The Federal Reserve's negative interest rate policy (inflation higher than interest rates) distorts both markets and the economy. Most voters care whether the distortions are in their personal interest.

            "What this country needs is a good five-percent savings rate," would invigorate the presidential race. Neither presidential candidate (Romney and Obama are assumed) will say this.

From the evidence, neither knows about the Federal Reserve's zero-percent, savings-rate policy. Neither seems aware of the constituencies they would attract. First and foremost are the voters who saved for retirement but are struggling to pay the rent. Is there a single public voice speaking on their behalf?

There are pension plans that will never pay beneficiaries if such low interest rates persist. There are good businesses tottering because they must compete with bad businesses that can borrow at 1%. The bad businesses run their operations like a roulette wheel. They always ran their businesses like a roulette wheel, but before Simple Ben took over the world, a 5% interest rate purged their foul practices from the economy.

There are small- to middle-sized banks that fight for survival because the bloated, Too-Big-To-Fail banks leverage their inscrutable balance sheets in daffy, derivative trades off minuscule interest rates. There are small- to middle-sized companies that traditionally borrow from small- to middle-sized banks, many of which were wise enough to forego Wall Street's antics and bonuses, only to find they must shrink their loan books because they are not members of the cabal. Of course, all of the above destroys jobs and precludes hiring. Yet, we can count on Romney and Obama to restrict their discussions to abstract job, housing, tax, and spending solutions.

This predicament came to mind when reading last week that Mitt Romney "criticized Bernanke for printing too much money." Such a foray seemed improbable, and, in fact, the quotation was an inaccurate extrapolation from another statement which is neither here-nor-there.

Back to the main point, Mitt Romney's two economic advisers, Greg Mankiw at Harvard and Glen Hubbard at Columbia, are just what you would expect if you expected nothing at all. Since Romney chose them, we can assume Romney is similarly garbed.

N. Gregory Mankiw sided against the 99% in the April 18, 2009, New York Times, under the headline: "It May be Time for the Fed to Go Negative." You can read all about it in "The 8% Solution." A quick search for Glenn Hubbard's quantitative easing position was unavailing, but to watch the documentary Inside Job is to know we have, as they say, "a team player."

Aside from Simple Ben's negative, interest-rate policy, these mastodons are incapable of planning for the future since they are working so hard at preserving the past. Glenn Hubbard published a forgettable budget plan in the April 25, 2012, Wall Street Journal. Larry Summers, gadfly economist, university president, and presidential adviser, responded to Hubbard's effort in the April 27, Financial Times. Summers rooted for President Obama's "plan that would cut deficits by more than $4 trillion over the decade."

Why even bother proposing or revising a budget that only cuts $4 billion over a decade when the U.S. Treasury is a couple of trillion dollars in the hole each year? Expecting that such debates will alter the nation's direction is far-fetched.

            It is na├»ve or vain to offer constructive criticism, but here goes: Stop making 10-year budget proposals. Concentrate on next year. Even that exceeds Washington's interest and ability, but at least there is a chance of concentration and accountability. We need look no further than Larry Summers to know how wrong and unaccountable are the brilliant economists who dominate public policy.

On February 7, 2000, Treasury Secretary Larry Summers presented the 2001 federal budget. The brilliant economist (he always seems to be described as "brilliant") averred: "This is a budget that preserves our progress and builds our future.... With respect to debt, this is a budget that...provides for the elimination of the national debt by 2013. That is, in effect, a major tax cut, in two respects. It is a major tax cut because it removes the burden of the interest payments on $3.5 trillion from the American people, and ensures that principal payments will not need to be made in the future."

Summers missed both the forest and the trees. When he spoke, it was obvious that recent federal budgets had caught a tailwind from Internet IPO's, stock-market gains, and stock-option cash-outs. That was the main reason for the-then recent federal surpluses. It required some intelligence to, say, disentangle a collateralized bond obligation, but the huge boost in government revenue was a matter of simple identification.

Hope may spring eternal, but the presidential victor in 2012 will dictate an economic policy that is stuck in the mud. What then, will break unsustainable imbalances and market interference? Lacking an untoward event, we will wait for the markets to revert. The currency and bond markets cannot be controlled forever. The form and speed of a reversion is unknown. The world is full of surprises. If rising inflation of things (not asset prices) is recognized by the general public, a scramble for stuff would upset the asset price-fixing of central banks.