Well now, Mr. Khurana has written a thoughtful piece, and he deserves credit for seeing what the Fed's own economists refuse to see: that the neo-Keynesian model, in which the interest rate is a dial the central bank turns to summon or suppress investment, simply does not match the facts of the last twenty-five years. He shows the correlation isn't there. Good for him. But having broken free of one error, he walks straight into another — he still thinks the interest rate is the main character in this story. It isn't. It's a bit player. The dollar itself is the main character, and nobody in this piece asks what the dollar is actually worth.
Let's go back to fundamentals, the ones this profession abandoned two generations ago.
Say taught us that production is the source of demand — a man works, and in working, creates the means by which he buys what someone else has made. Investment is not called into being by cheap credit; it is called into being by the expectation of an after-tax return on production. That's why Mr. Khurana's own data shows no correlation between rates and investment. Businessmen don't lie awake at night wondering if the federal funds rate is 1 percent or 5 percent. They lie awake wondering whether what they build will be worth more than what it cost — after the tax man and the inflation man have both had their say. Change the incentive to produce — through tax rates, through regulation, through the certainty of the currency you'll be paid in — and you change investment. Fiddle with the interbank lending rate and you change very little except who gets rich playing games with paper.
That brings us to Aristotle, who understood something the modern central banker has forgotten: money's whole purpose is to be a stable measure, a common denominator that lets a shoemaker and a farmer trade fairly. Aristotle also warned about chrematistics — the pursuit of money for its own sake, detached from the production of real goods. What does the Fed's stop-and-go policy over the last twenty-five years actually do? It makes the dollar an unreliable ruler. And when the ruler itself keeps stretching and shrinking, nobody wants to build a house with it — they'd rather trade the ruler. That, gentlemen, is financialization. It isn't caused by the price of credit being too low. It's caused by the value of the dollar being too uncertain. A merchant who doesn't know what his money will be worth in five years won't plant an orchard; he'll flip a stock.
Now to Ricardo, because there's a piece of mercantilist nostalgia buried in this essay — the notion that a strong dollar "hurts Main Street" by pricing out exports, and that a weaker dollar would bring manufacturing home. Ricardo settled this two centuries ago. Nations don't get rich by cheapening their currency to sell more abroad; they get rich by producing what they're best at and trading for the rest. A strong dollar is not America's curse — it is the world's vote of confidence in American production, and the proper response to deindustrialization is not currency debasement, it's removing the tax and regulatory penalties on domestic capital formation. Chase a weak dollar and you'll get Argentina's manufacturing base, not Germany's.
And Friedman — who I sparred with plenty in my day, mostly over whether the Fed should target the money supply or the price of gold — would still agree on this much: inflation, and its opposite, deflation, are monetary phenomena, not interest-rate phenomena. The author keeps conflating "the price of money" (the interest rate) with "the value of money" (what a dollar actually buys). These are not the same thing, and the Fed's whole tragicomedy since 2000 comes from treating them as if they were. You can hold rates near zero with a stable dollar, and you can hold rates at ten percent with a collapsing one. The rate is not the disease or the cure. It's a symptom.
So what would I tell Mr. Khurana? Don't ask the Fed to raise rates to "discipline" Wall Street — that's still the old central-planning impulse in a new suit, still the notion that some committee in Washington can find the one true price of credit that will make Americans build factories instead of buybacks. Ask instead that the Fed do the one job classical economics assigns it: keep the measuring rod fixed. Anchor the dollar — to gold, if you want a rule nobody in Washington can talk himself out of — and then get out of the business of setting rates altogether. Let the market, not the FOMC, decide what savers are paid and borrowers owe. Pair that with lower marginal rates on capital, the Laffer lesson this magazine's other writers understand well enough, and you'll get the productive investment boom the postwar Fed promised and never delivered.
Only a few items would I mention to clarify from my readings and take. You said, "Greenspan pushed rates well below inflation because he incorrectly feared a Japanese-style deflationary spiral."
I have read and believe that Greensapn lost control of interest rates due to Asian and primarily Chinese buying treasuries to lower their currency and to launder their surplus money. He said to Congress it was a "conundrum"? So, he didn't know what was happening or at least said that? Strange? Biggest reason the housing market went off the rails.
Alos, he many times kept saying adjustable-rate mortgages are great and a great new tool for the housing market?! What? really? and from a guy who never bought a house but always rented? How would he know right? lol funny
Warren Buffett’s preference for “economic castles protected by unbreachable moats,” ok Brij let's call a spade a spade. Monopolies. Monopolies were legalized and as Buffet said that's what he looked for and bought of course! lol Monopolies are poison just like socialism and communism is poison. Just the other side of the barbell. They reduce competition and kill markets like communism does. Monopolies were allowed again in the 1970's because they were more efficient? ok whatever.
I have recently come to believe that the entire green tech boom was possible only due to cheap hydrocarbons which where helped by cheap money allowing over investment in Fracking. Now that cheap money and cheap energy are gone (maybe forever) the overall green boom may ultimately be the true non sustainable technology.
No mention on the role of repeated Republican sponsored tax cuts as a cause of rising government debt and increased income and asset inequality. What does Brij think about equalizing the Federal income tax rate on capital and labor as a way or reducing the rapid rise in government debt and its long-term effect on our economy?
The Bush Tax Cuts were the proximate cause of the deficits in those years as Clinton had increased revenue via higher taxes. So under Clinton the economy boomed and the 2001 bipartisan tax cuts weren’t that irresponsible. The partisan 2003 tax cuts implemented in 2002 were the irresponsible round of tax cuts because the Bush administration couldn’t figure out that we were in a jobless recovery because of the China Shock. So we were adding worse jobs than the union jobs we were losing and we were losing manufacturing jobs at a rate that couldn’t be replaced by retail jobs. And so during an over 3% GDP growth economy Americans with health insurance started declining…and the population was getting older too!!
The Ghost of Jude Wanniski replies:
Well now, Mr. Khurana has written a thoughtful piece, and he deserves credit for seeing what the Fed's own economists refuse to see: that the neo-Keynesian model, in which the interest rate is a dial the central bank turns to summon or suppress investment, simply does not match the facts of the last twenty-five years. He shows the correlation isn't there. Good for him. But having broken free of one error, he walks straight into another — he still thinks the interest rate is the main character in this story. It isn't. It's a bit player. The dollar itself is the main character, and nobody in this piece asks what the dollar is actually worth.
Let's go back to fundamentals, the ones this profession abandoned two generations ago.
Say taught us that production is the source of demand — a man works, and in working, creates the means by which he buys what someone else has made. Investment is not called into being by cheap credit; it is called into being by the expectation of an after-tax return on production. That's why Mr. Khurana's own data shows no correlation between rates and investment. Businessmen don't lie awake at night wondering if the federal funds rate is 1 percent or 5 percent. They lie awake wondering whether what they build will be worth more than what it cost — after the tax man and the inflation man have both had their say. Change the incentive to produce — through tax rates, through regulation, through the certainty of the currency you'll be paid in — and you change investment. Fiddle with the interbank lending rate and you change very little except who gets rich playing games with paper.
That brings us to Aristotle, who understood something the modern central banker has forgotten: money's whole purpose is to be a stable measure, a common denominator that lets a shoemaker and a farmer trade fairly. Aristotle also warned about chrematistics — the pursuit of money for its own sake, detached from the production of real goods. What does the Fed's stop-and-go policy over the last twenty-five years actually do? It makes the dollar an unreliable ruler. And when the ruler itself keeps stretching and shrinking, nobody wants to build a house with it — they'd rather trade the ruler. That, gentlemen, is financialization. It isn't caused by the price of credit being too low. It's caused by the value of the dollar being too uncertain. A merchant who doesn't know what his money will be worth in five years won't plant an orchard; he'll flip a stock.
Now to Ricardo, because there's a piece of mercantilist nostalgia buried in this essay — the notion that a strong dollar "hurts Main Street" by pricing out exports, and that a weaker dollar would bring manufacturing home. Ricardo settled this two centuries ago. Nations don't get rich by cheapening their currency to sell more abroad; they get rich by producing what they're best at and trading for the rest. A strong dollar is not America's curse — it is the world's vote of confidence in American production, and the proper response to deindustrialization is not currency debasement, it's removing the tax and regulatory penalties on domestic capital formation. Chase a weak dollar and you'll get Argentina's manufacturing base, not Germany's.
And Friedman — who I sparred with plenty in my day, mostly over whether the Fed should target the money supply or the price of gold — would still agree on this much: inflation, and its opposite, deflation, are monetary phenomena, not interest-rate phenomena. The author keeps conflating "the price of money" (the interest rate) with "the value of money" (what a dollar actually buys). These are not the same thing, and the Fed's whole tragicomedy since 2000 comes from treating them as if they were. You can hold rates near zero with a stable dollar, and you can hold rates at ten percent with a collapsing one. The rate is not the disease or the cure. It's a symptom.
So what would I tell Mr. Khurana? Don't ask the Fed to raise rates to "discipline" Wall Street — that's still the old central-planning impulse in a new suit, still the notion that some committee in Washington can find the one true price of credit that will make Americans build factories instead of buybacks. Ask instead that the Fed do the one job classical economics assigns it: keep the measuring rod fixed. Anchor the dollar — to gold, if you want a rule nobody in Washington can talk himself out of — and then get out of the business of setting rates altogether. Let the market, not the FOMC, decide what savers are paid and borrowers owe. Pair that with lower marginal rates on capital, the Laffer lesson this magazine's other writers understand well enough, and you'll get the productive investment boom the postwar Fed promised and never delivered.
The rate was never the problem. The ruler was.
Great article Brij your spot on. Thanks.
Only a few items would I mention to clarify from my readings and take. You said, "Greenspan pushed rates well below inflation because he incorrectly feared a Japanese-style deflationary spiral."
I have read and believe that Greensapn lost control of interest rates due to Asian and primarily Chinese buying treasuries to lower their currency and to launder their surplus money. He said to Congress it was a "conundrum"? So, he didn't know what was happening or at least said that? Strange? Biggest reason the housing market went off the rails.
Alos, he many times kept saying adjustable-rate mortgages are great and a great new tool for the housing market?! What? really? and from a guy who never bought a house but always rented? How would he know right? lol funny
Warren Buffett’s preference for “economic castles protected by unbreachable moats,” ok Brij let's call a spade a spade. Monopolies. Monopolies were legalized and as Buffet said that's what he looked for and bought of course! lol Monopolies are poison just like socialism and communism is poison. Just the other side of the barbell. They reduce competition and kill markets like communism does. Monopolies were allowed again in the 1970's because they were more efficient? ok whatever.
Hey excellent write up thank you again.
I have recently come to believe that the entire green tech boom was possible only due to cheap hydrocarbons which where helped by cheap money allowing over investment in Fracking. Now that cheap money and cheap energy are gone (maybe forever) the overall green boom may ultimately be the true non sustainable technology.
No mention on the role of repeated Republican sponsored tax cuts as a cause of rising government debt and increased income and asset inequality. What does Brij think about equalizing the Federal income tax rate on capital and labor as a way or reducing the rapid rise in government debt and its long-term effect on our economy?
The Bush Tax Cuts were the proximate cause of the deficits in those years as Clinton had increased revenue via higher taxes. So under Clinton the economy boomed and the 2001 bipartisan tax cuts weren’t that irresponsible. The partisan 2003 tax cuts implemented in 2002 were the irresponsible round of tax cuts because the Bush administration couldn’t figure out that we were in a jobless recovery because of the China Shock. So we were adding worse jobs than the union jobs we were losing and we were losing manufacturing jobs at a rate that couldn’t be replaced by retail jobs. And so during an over 3% GDP growth economy Americans with health insurance started declining…and the population was getting older too!!