On Bernanke’s Folly

I’ve been asked a few times by email and in posts on the forum the following question: Were I Ben Bernanke, what would I do?

That’s pretty simple, really.

See, sound lending (absent intentional distortion by governments and central banks) is based on one fundamental fact: Borrowing always has a cost associated with it.

That is, to borrow money you must always pay a rate of interest that reflects:

  • The risk you will not pay.
  • The time value of money.
  • The imputed rate of currency debasement (inflation)
  • A profit.

Lending, that is, always (absent government interference) costs more than the risk-free rate of return, which is roughly the rate of growth in the economy plus that of inflation (if any.)  It has to because nobody ever lends intentionally at a loss.

Therefore, I would withdraw liquidity until this condition was established in the portion of the market that I have direct influence over (the overnight lending rate.)

I would also explicitly establish an inflation boundary for liquidity to be managed by the central bank defined as (productivity increase:0)% < x < 0% and make this publicly known.  (In other words the target would never be greater than zero, and might include a modest deflation in line with productivity improvements.)

I would also (very publicly) urge Congress to remove all tax incentives for borrowing so as to prevent tax policy from creating negative real interest rates in any part of the economy.

This would do a number of things:

  • It would make borrowing to consume or speculate expensive.  It should be.  Using borrowed funds for either purpose cannot be realistically prohibited or controlled; only through the mechanics of the free market does it remain at a reasonable level.
  • It would return personal saving and capital formation to the forefront of economic activity – where it should be.  True economic progress comes from savings (that is, excess retained capital after the costs of one’s life, whether personal or corporate, are paid), not borrowing (leverage.)  All leverage does is magnify both gains and losses along with (when abused) shifting the costs of bad decisions to others.  “Heads I win, tails you lose” does not lead to lasting economic prosperity.
  • It would collapse the remaining bubbles in housing and the stock market.  This would be met with severe resistance by many, including lawmakers.  My riposte to this line of attack is simple: You want DVD players to cost $50, not $500.  You explicitly shop for “low prices” every single day.  Therefore, if you want to buy a house do you want it to be cheap or expensive?  If I had to take that argument to the people directly, I would.  There are a lot of unemployed and house-less people who would like to change their status.  If I had to publicly go after organizations like the NAR as well, I would do so and I would not be polite about my views on what they’ve done to this nation and its economic stability. 
  • It would force federal, state and local governments to have an honest conversation with the citizens on services to be provided and taxes to be collected to fund them.  We’ve been radically unwilling to do this, but we must do this.  It is the only way to have a sustainable economy and avoid the trap that Greece has fallen into and other nations are currently circling that same bowl.  We must not fall into that trap.
  • It would force a rational debate and action on trade policy.  See, a trade deficit drains capital.  If you have a central bank that refuses to allow credit to inflate in that instance then a trade deficit is self-correcting as your currency becomes strong fast (there’s less of it) and this cuts off the arbitrage game in a natural and measured fashion in direct response to the distortions attempted by those running trade surpluses.  If the mercantilist nations don’t like this that’s too damn bad.

Monetary policy in a debt-based currency world is pretty simple; it’s a function of mathematics.  The growth of money and credit cannot exceed the growth in the economy in the intermediate term.  The mathematical law of exponents mandates that this be the case if you want a stable monetary and economic system. Since debt is tied to currency and debt repayment takes place over time you can run short-term differences if necessary to buffer shocks – but you cannot continually expand credit and money (summed) faster than production.

This, incidentally, is the essence of the FOMC’s actual charter – but it has been intentionally and willfully ignored.

In a non-debt-bearing currency system the requirements are much more strict.  In such a system money and credit (summed) must match production in the present tense.  This means that during economic slowdowns you must withdraw money and credit from the system, or you get immediate inflation (“stagflation”), which is insanely destructive.  It also means you must “deficit spend” during expansions!  This policy is politically difficult to implement as when the economy slows there are always screams for “more drugs!” to buffer the pain.  In a debt-based system over the short term you can provide some accommodation.  In a non-debt-based system you cannot without immediate monetary damage.

To those who asked: There’s my answer.

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