Is the Federal Reserve evil?

Recently I have seen a lot of talk about how evil the Federal Reserve is, and how Ben Bernanke is some sort of villain operating behind a curtain somewhere. I think most of this talk really misses the point of who is to blame for our predicament, and where our anger should really be aimed.

It is important to remember that the huge bailout bill (the "TARP") passed a year ago is not run by the Federal Reserve. It is being run by the Treasury and the taxpayers are on the hook for the money. I have a lot of problems with how that was done but the Treasury and the Fed are two separate things, the first being part of the executive branch and the second being an independent institution. As far as Ben Bernanke is concerned, I think he is about as good a guy as you could ever expect a Republican to nominate - he has spent his entire adult life studying monetary policy, and while he is too conservative for my taste he is a competent man, unlike some other Bush appointees we could name.

First, lets debunk one huge red herring. In a recent HuffPost post, Alan Grayson (who I love for all the obvious reasons) takes a page from Ron Paul's playbook and says we should tell our Senators to "vote NO on Ben Bernanke's confirmation until the Federal Reserve comes clean on what it has done with OUR money.

Not quite. This is not "our" money in the same sense that tax money is our money (or used to be, before the federal government withheld it). The money that the Fed is lending out isn't taken from somewhere else. The Fed is in charge of creating it in the first place. That is, the Federal Reserve is in business to decide how big the money supply should be. When they decide it should be bigger, they buy government bonds, which leaves the public holding more money and fewer bonds. Voila! A bigger money supply! When they want to shrink the money supply they can sell the bonds back again, and the public then has less money in their hands. None of this is tax dollars, nor do any of these transactions go through the Treasury.

So why did the Fed flood the system with huge amounts of money last fall, including going so far as to do it by buying up non-standard bonds such as mortgage backed assets? Because they were fulfilling the core mission for which they were invented a hundred years ago: to maintain the stability of the financial system by preventing our major financial institutions from melting down. Most folks don't really have any idea about this, but last fall we REALLY WERE on the brink of a COMPLETE AND TOTAL financial meltdown. That would have meant we would have seen widespread bank failures, corporate bankruptcies, layoffs and unemployment that would make the current situation look like heaven.

I don't fault the Fed for doing whatever it had to in order to avoid that. It is easy for people now to pretend it was no big deal, and there was no reason to get so excited, but they are just plain wrong. Ben Bernanke helped avoid a true disaster, and I am willing to accept a little sloppiness in the execution if he managed to succeed in his primary goal.

So what can we legitimately complain about?

First, about Ben B. What he is in charge of is deciding how big the money supply is, and his only tool is to create more money or less money. If he creates too much there will be inflation, which will impose a tax on everyone by raising prices. If this happens we can legitimately criticize him for it, but so far there is little sign of inflation - the figures have been bouncing around quite a bit, but that is more because of oil prices than anything Bernanke did.

But should we worry about inflation in the future? After all, we HAVE had a massive increase in the money supply, which a naive view of the economy would tell us is a sure sign of inflation to come. The answer is no, and for two good reasons:

1. The amount of money that was created is indeed huge by any standard. But what the Inflation Chicken Littles don't take into account is that this amount of money is far, far smaller than the asset destruction caused by the stock market collapse and various corporate failures of the past year or so. In fact, it is far less than the loss in value in the financial sector alone. In "normal" times, piling more cash on top of existing financial assets does indeed cause inflation. When the existing financial assets are shrinking before our eyes, not only is the additional cash just limiting the depth of the hole in our portfolios, it is actually giving people what they want. I certainly am happier holding more cash right now than I was a couple of years ago, aren't you?

2. If inflation picks up later on, it is something we have a great deal of latitude to deal with. Interest rates are near zero right now, so the Fed can sell a lot of those bonds it bought, and soak up a lot of cash by doing it, if inflation ever seems like a problem. In short, just as it can create money, it can "uncreate" it just as easily.

This brings up the big question - Is inflation the thing we should fear most? If so, then Ben B should shrink the money supply, resulting in higher interest rates now. Or is choking off the recovery a bigger danger? If so, then Ben B. should refrain from tightening money supply and let the monetary expansion continue for a while. It used to be that Republicans always worried more about inflation and Democrats always worried more about jobs. Being a Democrat, I am far more worried about the unemployed people than I am about inflation, which is so low it is a marvel that anyone is seriously worried right now.

And as for what Ben B says in public, don't sweat it. His predecessor, Alan Greenspan, made a career of opaque impenetrable statements that people would pick over like Kremlinologists studying who stood next to who at the Moscow May Day parade. Ben B isn't quite as good as Alan G at making opaque statements but he is getting there. Bottom line - the reason his statements sound vague and unintelligible is because he trying not to say anything at all. What people read into his statements says more about whoever is divining his meaning than it does about Ben B because usually there isn't much meaning there in the first place.

But I have a far bigger problem with all of this. Basically, it is that the brain trust in the White House seemed to only see the financial crisis as a top-down problem. Fix the big banks and all is well as far as the administration is concerned. I have no problem with fixing the big banks, but what about help for the people who are really in trouble? Sure, we passed a stimulus bill, but it was pretty small compared to what we really need, and about a third of it was in the form of tax cuts, which aren't much help to unemployed people who haven't lost any income to tax. Banks and credit card companies are furiously regrouping, but are doing so at the expense of consumers who are suddenly being denied loans and seeing ridiculous increases in interest rates.

Comparisons to FDR are pretty routine but there is one thing Roosevelt never forgot - who voted him into office in the first place, and who he wanted to vote for him in the next election. He made damn sure to butter the bread the little guys were eating, because without them he wouldn't have kept getting reelected, nor would he have bequeathed a 50 year dominance to his party. He didn't do it with bipartisan support either.

Roosevelt's major economic accomplishments for the little guys (e.g., Social Security, Federal Deposit Insurance) were done over intense Republican opposition, and lots of claims that he was a socialist or a communist. That didn't make him compromise. It made him twist arms all the harder. And when the little guys still needed jobs he didn't cower in the face of Republican accusations - he went out and created a program that gave them jobs (the WPA). Was it socialism? Of course. Was it a good idea? If you wonder about that ask any of the 15 million people who are unemployed right now what they would think if the government offered them a job doing anything at all useful. Then ask yourself who they will vote for in the next election.