Better to engineer a mini-crisis while you’re still in control than let a crisis you can’t control run away from you.
One of the most widespread misconceptions about the Federal Reserve is that its policies are based solely on economic data and models. This misconception is not accidental but the result of carefully managed public relations: The Fed fosters a public image of dispassionate experts working econometric magic that mere mortals (i.e. non-PhDs in Economics) cannot possibly understand.
(Insert joke about one-armed economists being unable to say “on the other hand” here.)
The reality is the Fed is as much a political and PR machine as it is a financial institution. Behind the carefully nurtured facade of experts poring over data and complex financial models is a leadership that spends an inordinate amount of time on PR and perception management (care to count the number of Fed-staged speaking engagements and press conferences this year?).
The Fed is an intrinsically political entity, and its leadership is by necessity thoroughly political. In public, the Fed leadership plays the part of dutiful technocrats to perfection, but behind this mask they are keenly aware that the elected leadership of the nation has relied on the Fed’s easy money to enable stupendous deficit spending.
The Fed’s mass money-creation and bond buying programs have allowed the elected leadership (the Executive branch and Congress) to avoid any tough decisions; being able to borrow trillions of dollars at near-zero real rates of interest means never having to face difficult spending choices: need another trillion to fund politically powerful cartels? No problem, just borrow it. The Fed has our back.
The Fed has a dual mandate, and no, it’s not stable prices and employment. The Fed’s real dual mandate is:
1) Preserve and protect the banking sector’s power and share of the national income
2) Preserve and protect the Fed’s political and institutional power.
The second mandate requires a complex dance with the elected leadership of the nation. The Fed needs to be needed, and so funding the political Elites’ borrowing gives the Fed abundant political power. The political class cannot afford to alienate the Fed leadership when they depend on cheap money and trillion-dollar bond buying to sustain their own power.
But the political class’s abject failure to deal with the fiscal morass is pushing the Fed into a corner it cannot afford to be trapped in. The longer the Fed prints $1 trillion a year to make things easy for the elected toadies and apparatchiks, the greater the risk that the financial system destabilizes again and the Fed will shoulder the blame.
The political class plans to be on the sidelines during the next financial crisis, innocently tsk-tsking while the Fed absorbs the blame for the fiasco. The Fed is desperate to pass the ticking time-bomb back to the elected leadership before it blows, and there is only one way to do this: taper off the money-printing and bond buying, and accept a mini-meltdown in stocks as the cost of forcing responsibility back on on the elected leadership.
Fed Chairman Bernanke has telegraphed the Fed leadership’s concern about the free pass the elected leadership has been given on the fiscal side, and now that his term is ending, Bernanke is aware that the clock is ticking not just on his legacy but on the critical task of handing the responsibility for fiscal management back to the elected leadership.
While doing nothing will let him leave the stage in December with the appearance that everything is in good order, he knows that he’s handing the next Fed chair–and more importantly, the Fed itself–a no-win situation: if the global financial system destabilizes, the Fed will have few (if any) options available to save it that don’t trigger risky unintended consequences.
Should the financial system slip into crisis again, the Fed’s opportunity to force responsibility back on the elected leadership will have passed.
Politically, it’s now or never for the Fed, and Bernanke is keenly aware of this. From the point of view of the Fed, it has patiently given the elected leadership four long years to get its house in order, and the political class has chosen the easy way out: do nothing of any substance and borrow $7 trillion to fund every politically powerful cartel and constituency.
Bernanke is also aware that he needs to give the Fed (and the next chairperson) some policy leeway: if the quantitative easing machine’s throttle is already maxed on 10, the Fed leadership will have precious little maneuvering room left in the next crisis.
To preserve its political power and avoid taking the fall during the next crisis, the Fed has to taper off its money-creation and bond buying well in advance of December. The majority of commentators in the financial media see the stock and bond markets as not just the most important metrics but the only metrics. This reflects their self-absorption and political naivete; the markets are ultimately theater and PR leverage for the real power plays.
The best way to (ahem) get the attention of the political class is to taper now, trigger a stock market decline and speak directly to the elected leadership’s need to put the fiscal house in order.
This is the only way the Fed can escape taking the bullet during the next financial crisis. ”We told you so” is much better than “we did everything we could and it still fell apart.” Better to engineer a mini-crisis while you’re still in control than let a crisis you can’t control run away from you, and better to pass the ticking time-bomb to the elected leadership while you still can.