The new secret weapon to combat deflation - how funny, it looks like a printing-press
Business news (Filed: 06/01/2003)
The President wants us to know he means business. Tomorrow he will deploy his economic task force, designed to rout the forces of recession.
Tax cuts, some of them mounted on dividends, will drive deep into no-man's-land and lead a general advance. It will be all over before the hot weather, or if not, the Federal Reserve will launch its secret weapon.
The task force will rely on conventional weaponry, used on an all-American scale. These "package" tactics have been tried on our own economy from time to time, although not lately. On the battered terrain of Japan, the general staff has now sent a dozen packages over the top, and none of them has got beyond the barbed wire.
The Fed, too, has had to think again about its weapons and tactics. Interest rates are its standard equipment, and Alan Greenspan, its veteran commander, has fired off a long barrage of interest-rate cuts at assorted enemies. He has sometimes been given the credit for saving the world, but he is still on the defensive.
Two months ago he brought the Federal funds rate down by 0.5pc to 1.25pc. That was a bold move but not one that he could go on repeating indefinitely. He is short of ammunition. After three more cuts like this, he would be paying the banks to take money away from him. New thinking would be needed.
It has come from Ben Bernanke, who was recruited from Princeton to the Federal Reserve Board and seems to have brought the plans with him. They make the Fed's secret weapon resemble a printing press, and Mr Bernanke says that it is one. The government, so he explains, can use it to produce as many US dollars as it wishes, at virtually no cost.
What would it do with all these dollars? Hand them out? Drop them from helicopters? Not exactly, although it could achieve much the same effect by less flamboyant means. The Fed could, so Mr Bernanke suggests, buy Treasury bonds and other securities from the banking system. It could lend the banks money at low rates of interest or none, and not be too choosy about the security it takes.
Mr Bernanke clearly brings his own perspective to his work. He is a learned economist, a student of money and credit, and the author of a new book on the Great Depression of the 1930s. He has no wish to write the sequel, and if a loosening of monetary rectitude is what it now takes to ward deflation off, he would be for it.
From a central banker, even a new recruit, this is quite something. Ever since William Pitt tried to ravish the Old Lady of Threadneedle Street, central bankers have been supposed to believe in monetary virtue, not in organised debauchery. A mother superior might as well announce that her convent would be open to free love, or love on reasonable terms.
No wonder that Barton Biggs, the sage of Morgan Stanley, suggests that this declaration is an era-changing event. The Fed now has a vigilante on its board: not so much a super-dove as a deflation hawk. His presence goes to show how far deflation has moved up the central bankers' worry-lists.
They can see that in Japan, where deflation is entrenched, the central bank has long ago run out of ammunition and ideas to combat it. They will want to be sure that this fate does not happen to them. Mervyn King, the Bank of England's governor-designate, has said that central banks around the world will do their best to prevent deflation.
Thanks to Mr Bernanke, they have the technology, and Professor Tim Congdon at Lombard Street Research says that there is nothing new about it. (Another ground-breaking British invention, developed in America . . . )
Twenty years ago the Bank was trying to mop up excess money in the system by selling more government stock than the Treasury needed to issue. The process would work just as well in reverse, and it has.
This was one reason why Britain once led the world in stagflation: a sluggish or stagnant economy in which inflation persisted. A hint of stagflation today is that all the world's four major currencies are perceived to be too strong. They cannot all be over-valued against each other, but they may be in terms of the goods and services they buy. So the prices of oil and of gold have been rising.
Such are the perils that go with the happy illusion that policy-makers can exchange the economic cycle for an endless escalator. Here, chancellors claim to have broken the mould or to have abolished booms and busts.
Mr Greenspan never claimed that, but he did not need to. In the new economy, the rules seemed to have changed for the better. Now here it is, all set to keep the escalator running, and with an advanced set of tools in his bag. In the Great Depressiom, his predecessors at the Fed were trying to stabilise the economy.
Friedrich Hayek, the great liberal economist, thought they were making things worse, by repeating, in a slump, their mistakes from the boom: "Monetary policy all over the world has followed the advice of the stabilisers. It is high time that their influence, which has already done harm enough, should be overthrown."
We have yet to hear Mr Bernanke's gloss on that, or to see his weaponry in action. Perhaps his smart bombs would do all that he hopes of them, but few bombs are smart as all that, and none is smarter than its aimer. Stand well clear.