Tocqueville as Prophet

“The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.”

Alexis De Tocqueville, Democracy in America (1835)

Last week the economic central planners at the Federal Open Market Committee (FOMC) of the Federal Reserve Bank issued a statement tempering their previously optimistic forecast for recovery from the “Great Recession”.  In its statement, the Ben Bernanke led FOMC indicated that the weakening recovery has made it necessary for the Fed to keep interest rates at “exceptionally low levels…for an extended period”.  Additionally, the FOMC stated it will change course.  Instead of shrinking its historic $2 trillion balance sheet, the Fed will reinvest money from maturing mortgage bonds to buy up more assets (notably government treasury bonds).  All of this will be done in an effort to further stimulate the markets to recovery.

No one doubts that something needs to be done to reverse the downward spiral that our economy is once again taking.  After all, consumer confidence is down, factory orders are down, the real unemployment rate which takes into account discouraged and underemployed workers is still north of 16 percent, Food stamp usage has skyrocketed to a record high of 40.2 million recipients, and  Bank repossessions and foreclosures are still a massive problem.  No, nobody doubts that something needs to be done, but that something should not be more of the same that got us into this mess in the first place and is keeping us in it in the second.

Now, I would not question the intelligence of anybody on the FOMC.  Bernanke and his comrades are smart folks.  They all have fancy degrees and have spent years on Wall Street and/or in the government cutting their teeth becoming seasoned economists and financiers.  They certainly are not “wet behind the ears” as is said in the business.  So then if it is not mental ability maybe it is motives that drive the FOMC members to pursue what appear to the reasonable layman as an insane policy.  Let’s analyze the situation further by looking at historical examples.

Faced with double digit inflation and an unemployment rate of 11-12 percent in the early 1980’s, then Fed chairman Paul Volcker did exactly the opposite of what our current Fed commander has done.  He raised money market rates to 19 percent.  It was painful at first, but in the long run the policy broke the decade long grip that stagflation had on our economy and ushered in a decade of solid economic growth.

Then we can point to Japan’s horrible experience with “quantitative easing” in the 1990’s as another example for objecting to the FOMC’s lamebrain policy.  Japan’s financial meltdown in the early 1990’s like ours this time was caused by government induced easy money and real estate speculation.  Once the bubble popped the Japanese powers that be pursued a policy of massive fiscal stimuli, propping up of insolvent banks, and discriminatory credit allowances. Sound familiar?  All in all, in the decade of the 1990s Japan passed 10 fiscal stimulus packages worth more than 100 trillion yen.  Instead of curing its economic ills the spendthrift policy led to what is now known as the “Lost Decade” in Japan.  In fact, many economists claim Japan has still not recovered.

Of course, Bernanke will make up excuses why the same policy he is pursuing for the U.S. didn’t work for Japan but will work for us.  Actually, all he really has to do is reference noted Keynesian economist Paul Krugman who says both Japan in the 1990s and the U.S. today simply did/have not spent enough to stimulate their respective economies.  Unfortunately for Bernanke at least two of his underlings don’t buy the argument.  In March of 2009 Timothy Kehoe, Edward Prescott of the Minneapolis Fed and a team of 24 economists from around the world published a report indicating that it is the “overreaction” by government which “prolongs” and “deepens” economic downturns.  In fact, if you look at the three crisis in the last 100 years where government has overreacted the most (the Great Depression, Japan’s Lost Decade, and our current crisis) they are also the longest lasting.  This is a fact that seems to solidify Kehoe and Prescott’s conclusion.

Lastly, the U.S. government has tried quantitative easing and Keynesian economics to solve our most recent troubles for close to 3 years now.  When the “Great Recession” began in December 2008 the national debt was a little over $9 trillion.  As I write this article, our debt is more than $13.3 trillion.  And this doesn’t count the trillions of dollars in easy credit doled out by the Fed to induce banks to loan again.  The longevity and size of the effort can only make one wonder about the motives of the FOMC to pursue more of the same.  Could it be that we are missing some information only available to the Fed?  Or could it be that Tocqueville was correct when he prophesized that Congress would discover that it can bribe the public with the public’s money.  We are talking about the Federal Reserve but who chartered the Fed and refuses to audit its books – Congress.  What’s unknown, given our current circumstances, is how much longer our republic can endure?           

Article first published as Tocqueville as Prophet on Blogcritics

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