It is comforting to think that the worst of the economic meltdown may be behind us, that hopefully the extreme volatility of the markets has abated somewhat and they have found their bottom for the time being, but I fear a more profound and longer lasting negative impact from the “cures” that have been applied and proposed. The most destructive policy has been the Federal Reserve’s failure to honor its most important responsibility–to preserve the value of the dollar.
Believe what you will about the causes of the recent crisis, but the political corruption of Fannie and Freddie, the failure of regulatory oversight, and the overreach of Wall Street product engineering would have produced relatively controllable aberrations were it not for the enabling availability of oceans of excess dollars that financed the debacle. Aside from this role played by the Fed’s monetary policy over the past five years in misallocating capital in excessive amounts to the subprime mortgage market, the policy that has been pursued over that period has been destructive in a number of other respects. It has used a cheapened dollar as an instrument of trade protection, thereby significantly damaging U. S. credibility in world markets, which for the country that manages the world’s reserve currency is absolutely critical to world order. It has undermined the world’s pricing discipline, for our markets can operate to clear themselves only in an environment of rational pricing based on the value of underlying goods and services without the manipulation of exchange rates by central banks. It has destroyed the anti-inflation discipline of the past 25 years and, with the prospect of new “stimulus” plans proposed by the Obama administration, which can only be financed by the creation of many billions of additional dollars along with the expected tax increases, it will be the accomplice for what I fear will be a renewed round of 1970s-style stagflation, which will have repercussions for entrepreneurial activity far beyond its immediate impact on inflation and prices.
My hope is that, as a principal advisor to President Obama, Paul Volcker will speak forcefully against this continued misdirection in Fed policy, although it appears that he may be in the minority on the new economic advisory team. As for the longer term, we need a revived Bretton Woods type compact among a new league of democracies, one that will restore gold backing to the dollar and tie the dollar to the world’s currencies. Our role as the keeper of the world’s reserve currency and our stewardship of order in world financial markets is much more than a good strategy, it is a moral obligation and we have failed to uphold it.