Haunted by Ghosts of the Old Eastern Bloc

Jerome Powell, the new Chairman of the Federal Reserve, just completed his third week on the job.  He’s hardly had enough time to learn how to operate the office coffee maker, let alone the all-in-one printer.  He still doesn’t know what roach coach menu items induce a heinous gut bomb.

Yet across the planet, folks high and low are already telling him exactly how he should do his job.  What’s more, they’re passing advanced judgement on things that may or may not happen.  For example, the South China Morning Post recently offered the following opinion:

“President Donald Trump may have done Janet Yellen a favour by not giving her a second term as Chairwoman of the Federal Reserve.  Her successor, Jerome Powell, may have inherited a poisoned chalice.  The Fed will have to up the pace of U.S. rate hikes or risk accusations of being behind the curve as markets react to signs of rising inflation.”

When Powell showed up to work on February 5, for his first day on the job, the general consensus was that the Fed would raise the federal funds rate three times this year, at 25 basis points – or 0.25 percent – per increase.  But now that consumer prices are rising at an annual rate of 2.1 percent, average hourly earnings are increasing at an annual rate of 2.9 percent, and Congress has passed a massive two year budget deal, twitchy economists are questioning if three rate hikes will be enough to keep inflation in check.

Over the last two weeks their chants for four rate hikes in 2018 have grown louder.  Goldman Sachs has even floated the five rate hike scenario.

Alas, this is the sort of ridiculous minutia that policy makers and analysts must navel-gaze over in a planned economy.  The truth is, Powell can’t win regardless of what he does.  Whether he raises rates three times or four times – or ten times – he’ll get it wrong.  Here’s why…

Chronic Shortages

The economy is a complex living organism that’s continuously evolving and always subject to change.  One relationship at one moment can be completely different at another moment.  Supply and demand are incessantly adjusting and readjusting to meet the conditions of the market.

These continuous interactions provide a natural and efficient response to supply shortages and gluts.  Even in a moderately free market economy, bakeries do not run out of bread when there’s a wheat crop shortage due to a late season frost.  The shelves never go empty.  Rather, the price of bread rises and consumers adjust their spending accordingly.

Centrally planned economies, on the other hand, are inclined to frequent, intensive and chronic shortages.  Bureaucrats, armed with spiral bound planning reports and pie graphs, are incapable of fixing the proper prices for gumballs and gasoline by diktat.  There’s simply too much going on and too many moving parts for them to consider.

With the best of intentions, the noble planner makes their best guess of the appropriate price control.  Then things invariably go haywire.

In practice, the supply of certain goods or commodities may be more than adequate.  But when a price administrator enforces an artificially low price, consumers are prone to wasteful behavior.  They’re compelled to demand a greater amount than is supplied.  Hence, the store shelves remain perpetually empty.

Certainly, uniform standards work well for units and measurements.  They’re critical to building consistency and standardization of hardware and parts.  They’re even necessary to effective communication and computer programming.  For certain things, however, uniform standards come up short…

Haunted by Ghosts of the Old Eastern Bloc

When it comes to the pricing of goods, commodities and services, commanding fixed prices by a central authority is an utter failure.  This was effectively proven by the experiences of the centrally planned economies of the old communist Eastern Bloc countries during the second half of the 20th century.

Regrettably, price controls don’t stop with just goods, commodities, and services.  The United States, Europe, and Japan have been doing their darnedest during the early years of the 21st century to show that these ghosts of the old Eastern Bloc also haunt credit.

Remember, credit, like a commodity or good, has a price attached to it.  The price of credit is the rate of interest a lender charges to a borrower.  Like fixing the price of a commodity or good by a central planning authority, fixing the price of credit by a central bank – such as the Federal Reserve, European Central Bank, or Bank of Japan – is presently being shown to also be an utter failure.

Someone with even a dim perception of the world around them can peer out and discern many strange and grotesque occurrences: Housing prices that far outpace incomes.  Total household debt at $13.5 trillion.  And an entire generation of Millennials that went $1.4 trillion in student loan debt for college degrees that have been debased in stature to what a high school diploma represented for prior generations.

These represent gross misallocations of capital.  What’s more, they would’ve never come into existence or ballooned out to this magnitude without the Fed’s credit market price controls.

Fed Chairman Powell doesn’t stand a chance.  Bernanke and Yellen before him oversupplied the economy with cheap credit.  Now Powell must mop it up with higher interest rates.  Yet because the U.S. economy’s been pushed to the brink with record debt levels it simply can’t afford higher interest rates.

Without question, Powell will find the break point.  Moreover, when the next great liquidity crisis hits it won’t be a failing of free market capitalism.  It’ll be the failing of the central planners and the system they wrought.


MN Gordon
for Economic Prism

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