Way back in August of 2007 I wrote here that the market was as much about psychology as it is about anything else. That post started a long-running series of me writing blog posts and columns on the economy. I had no idea at the time that such things as “credit default swaps” were even allowed, or else my warnings would have been even more strenuous. But I really think the Fed action I described 14 months ago is what started the unraveling that has reached today’s crisis levels. And at every step of the way, I have written that Bernanke and Paulson (and Congress and the White House, if applicable) did exactly the opposite of what they should do — and also warned last winter that we would start to experience stagflation by mid-summer if we didn’t work then to strengthen the dollar, cut the right taxes, and cut spending; and that if we did not do those things to head off a crisis, the economy would tank and would drag down McCain’s campaign with it.
In coming days I hope to reprint or link to some of those columns and blog posts, AND to explain why I still believe that, despite it all, and despite McCain’s panicked and idiotic handling of the credit crisis so far, McCain still has a chance to turn this election around. But it won’t be easy.
Anyway, here’s what I wrote back in August of 2007 — and remember, it was panicked bank run (i.e. psychology), not a lack of cash reserves, that killed Bear Stearns. Here, from Aug. 2007:
I am no expert on monetary policy, but I have been developing a theory for years that the few things actually done by the Federal Reserve Board Open Market Committee have at least as much impact on the psychology of investors and businessmen, at least short-term,ï¿½as they do on their actual economic bottom lines. My proposed solution is for the Fed at times to send not one but two signals at its meetings, with those signals deliberately appearing to contradict each other. For instance, it could raise theï¿½fund rate while indicating, in its accompanying statement, that its bias thereafter would be in favor of guarding against a recession. Or, in the case of today’s circumstances, it could do just the opposite — which is what I wish it had done yesterday. What do I mean? Well, it could do at least a tiny bit to ease the current credit crunch by lowering the fund rate by a quarter point, while at the same time in its statement saying that fighting inflation remains not only its primary concern foing forward, but that its anti-inflation vigilance will be enhanced BECAUSE it just cut the funds rate and so must watch out to ensure that inflation doesn’t result FROM that move.
Why would it do that? Because it gives everybody something to like. The tight-money folks would be reassured that the Fed’s move does NOT signal a change in its commitment to fighting inflation and does NOT signal a change in long-term strategy. But investors AND potential home-buyers looking for a reason to be bold would see an opportunity to actually make the leap — knowing that the new, lower rates might not last long, but that they are available now to improve their deals at the margins. If economic activity, especially in the building sector, moved up even a little bit as a result, it would stopï¿½any negative psychological snowball effect from developing. When it comes to big-money decisions by ordinary people, both optimism and pessimism feed on themselves. Right now, pessimism reigns in the building market. the pessimism is not at crisis levels yet, but it needs to be kept from reaching crisis levels. A small rate cut could be the difference needed to avoid such a crisis of pessimism.
Now, a major caveat: I would prefer that the Fed do less rather than more fine-tuning of the economy. Many of my supply-side friends would prefer that the Fed change its entire approach and target dollar-price stability (by buying and selling bonds, I think) while letting the Funds rate float. That would be fine with me. But if the Fed is going to continue its game of interest-rate manipulation, which it seems determined to do, then I would rather that it show show an understanding that it has a recent history of overshooting its targets, and therefore a willingness to ct to mitigate against bad results therefrom…..
I await the outraged howls of monetary experts from all sides of the debate. I offer this, therefore,ï¿½not as a definitive policy prescription, but as a suggestion to be considered in recognition that money these days is such a fast-moving commodity that the market, and the minds of the market’s investors, will affect money’s supply and its value as much as any group of central bankers can do.