Speculative Bubbles at the Fed

When I unfurled my weekend WSJ I found, beneath the fold, evidence that it’s editors or even the Fed might, just might, be reflecting critically on the deregulation of financial markets that have plagued the US economy since the late 1970s (Dec 12-13, 2015 “Fed’s Unsolved Puzzle: How to Deflate Bubbles” A1). The opening paragraph gave me reason to hope:

Federal Reserve officials participating in a “war game” exercise this year came to a disturbing conclusion: Six years after the financial crisis ended, the central bank remained I’ll-equipped to quell the kind of dangerous asset bubbles that destabilized the savings-and-loan industry during the late 1980s, tech stocks in the 1990s and housing in the mid-2000s.

Here it comes. I can’t believe it. A solemn confession. An about face. Shame. Remorse. And then — Hallelujah! — recommendations for reining in financial markets with higher taxes on capital gains and more rigorous protections against speculation. But then comes the rub: the Fed can (1) increase/decrease monetary supply; and (2) increase/decrease interest rates.

It is up to Congress to effect fiscal policy: increase and target federal spending on social goals the public has reason to value; increase and target federal revenues in ways that encourage investment in goods that the public has reason to value. The Executive enjoys limited authority where the former is concerned. For most spending, however, the Executive needs Congressional approval. Where the latter, revenues, are concerned, the President is virtually powerless.

In the 1890s the way to deflate bubbles was to make speculative investment so onerous as to compel investors who desire a return to perform due diligence on the long-term value of their investment. In the 1920s, likewise, investors should have looked askance at the unbelievable returns to be had during the post-war speculative boom. And, specially after the JP Morgan-backed speculative boom generated by the Dawes Plan, investors should surely have known (which doubtless they did) that their good fortune could not last. It did not. And in the 1950s and 1960s, investors should have known that eventually Japan and Germany would be back in the game and that their corner on global markets would soon evaporate in a downward spiral arising from competitive pressures.

In each one of these instances the responsible thing to have done would have been to spread efficiencies downward and outward to the consumers responsible for creating these efficiencies in the first place. At the very least this would mean that, instead of throwing money at assets — commercial real estate today, oil tomorrow, virgin forest lands the next day — promising today’s highest albeit ephemeral returns, investors would be moved to invest their money in the communities and their futures — sustainable energy, transportation, education, the arts — by which all of us are and continue to be enriched.

Yet, here as elsewhere in the world, because legislators and speculative investors are, if not identically the same people, dependent on one another’s good will, there is no will in Congress to divert capital from speculative bubbles to sustainable community development. However, it gets worse, because there is now a move in the Republican Party to make the Fed subject to Congress. Now wouldn’t that be sweet.

Yes, the Fed has no answer to bubbles. Nor should it. That, unfortunately, is in the hands of the Republican-controlled Congress. And we know how well that has turned out.

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