Our Friend the Fed (April 25, 2005)

(Part one of a two part series; part two appeared on February 7.)

(The Fed meets on May 3)

Montesquieu, a French guy who is sort of a founding grandfather, developed this notion to create three separate but interconnected branches of government – the executive, the legislative and the judicial.  His intellectual kids, the founding fathers, were keen on the ideas.  However, there was considerable disagreement and no agreement regarding the fourth branch of government – the economic.  (Shortly after the big gathering in ’87, the boys gathered again in ’91 and sagely addressed the concerns of the Fourth Estate in special interest legislation known as Amendment Uno.)

Later, in 1913, under the administration of someone who now would be known as a tax and spend liberal, a measure was passed to take a little money from all of us and another bill was passed to determine how much money we got to play with to begin with.  The Internal Revenue Act of 1913 (as amended) has gotten traction, although the 16th Amendment is not a household concept.  The activities and agendas of the scheming group of bankers who constitute the fraternity known as the Federal Reserve have never been adequately incorporated into our constitutional democracy.

The bankers establish monetary policy.  This is where most people turn to the racing form.  Monetary policy determines everything.  Put the racing form down and listen.  However, there is no constitutional blue print to guide the bankers.  Some of their tools are goals; some of their goals are tools.  The fellows who work with the Fed have not made news because they prudently stay out of the news.  They say it is okay to be rich, but it is not okay to be famous or infamous.  Few of them get involved with showgirls, at least not publicly, or wear collars that are not button-down, at least not publicly.  However, their actions make the news and determine the news.

What they do determines what we get to do.  The economy was slumping some time ago.  The jobs were going overseas and the stock market was going down the drain.  Many people who own houses (and vote) found that others coveted their houses.  Housing prices for existing stock went up.  The homeowners’ stocks had gone down, but they felt good that their housing stock had gone up.  The Fed flooded the economy with money by setting a low Federal Funds Rate and left us all, yup, awash in money.  There were also more people who needed and/or desired a house or a bigger house or an even bigger house, so more were built.  Low interest rates were a way of salvaging the American economy.  The homes were built on American soil, driving up the price of American soil owned almost entirely by Americans.  The homes were built with products made largely in America or Canada (wood, synthetic wood products).  The homes were built here in America by Americans, albeit a few who are categorized as “illegals” even though they are building America.  The one thing that Americans can do well here in America (and foreigners cannot do here in America) salvaged the economy.  And left us with a lot of big homes.

At what cost?  Low interest rates exacted a cost.  Many members of the Greatest Generation (they were) cobbled together a very comfortable retirement from 1) their employers who at one time actually provided adequate defined-benefit plans, 2) their government that at that time provided adequate social security benefits, and 3) themselves via interest payments from savings or bonds or other fixed-income investments.  The Great Triumvirate sustained them.  In a pinch, these good people retired comfortably by selling the home they purchased in 1953 and spent their last years bass fishing at the cabin.  The mortgage interest deduction rewarded them during their productive years; the $250,000 exemption from income on the sale of a personal residence protected the usufructs of their efforts and good fortune.  It was a good time in a good country.

What about all of those individuals who relied primarily on interest payments to finance their retirement?  Prudent personal financial planning and the insistence of the actuarial tables dictated that these seniors get out or stay out of risky investments as they got older and instead invest in regular interest-generating fixed income instruments.  However, they got little for their money and their efforts in recent years.  If they were fortunate enough to pay off their house and later sell it and if they could also could rely on 1) and/or 2) above, they could live comfortably in the smaller house.  Seniors without 1) and/or 2) above may strain to live modestly.

However, why not set the Federal Funds Rate at ten percent instead of one percent?  The old folks would receive more interest, although there may be restrictive pressure on growth.  Those who demand a return to the gold standard seek a standard, although the metal does not set standards.

The Fed had been allowed to operate under a loose alliance without congressional oversight (or with congressional oversight?).  For decades, the Fed addressed monetary policy and avoided fiscal policy.  The Fed’s current helmsman has been opining on fiscal policy of late.  Admiral Alan “Enron Award for Distinguished Public Service” Greenspan is adrift.  The Fed is the most significant player setting the course and speed for the economic ship of state.  There is no constitutional rudder to guide them.  The statutory helm is loose.  Incorporating the Fed into our constitutional scheme of democratic government is one of the challenges today.

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