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,�as 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
the�fund 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
stop�any 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,�not 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.
