What id the Fed was not an “interest rate trader”?
I was reading the following article at the CATO Institute
The incoming administration must think about that possibility because the timing of boom and bust cycles seems to be shortening. The next bust could come five or six years from now — or about in the middle of an Obama second term. Should that happen, Mr. Obama would be unable to blame Republicans for the mess and would be tagged as the second coming of Jimmy Charter.
To avoid such a fate, Mr. Obama needs to stop the next asset bubble from being inflated by imposing a commodity standard on the Fed. A commodity standard (such as a gold standard) imposes discipline on a central bank because it forces it to acquire commodity reserves in order to increase the money supply. Today the government can inflate asset bubbles without paying a cost for it because the currency isn’t linked to the price of a commodity.
With a commodity standard in place, the government would also have price signals that would alert it to the formation of a bubble. Why? Because the price of the commodity would be continuously traded in spot and futures markets. Excessive easing by the Fed would be signaled by rising prices for the commodity. In recent years, Fed officials have claimed that they cannot know when an asset bubble is developing. With a commodity standard in place, it would be clear to anyone watching spot markets whether a bubble is forming. What’s more, if Fed officials ignored price signals, outflows of commodity reserves would force them to act against the bubble.
The point is not to deflate asset bubbles, but to avoid them in the first place. Imposing a commodity standard is a practical response to the repeated failures of central banks to maintain sound money and financial stability. What would be impractical is to believe that the next time central banks will get it right on their own.
It got me to thinking…
So, isn’t the Fed essentially a trader now? Just about once a month (assuming no inter-meeting action) they make a “trade” on interest rates (raise, lower, hold) based on the current information. The decisions they then make set the country on an economic course.
But, what if the time frame is just too short between meetings? We know based on all evidence the shorter the time frame we make between a decision the more likely that decision is going to be flawed. Yes, I know the Fed is filled with a bunch of smart folks with PH.D’s but history also tells us the number of letters following a name has no correlation to the ability to avoid making spectacular mistakes, only the ability to explain them away after (Mr. Greenspan?).
What if the Fed was only allowed to meet and make rate decisions quarterly? Berkshire’s (BRK.A) Warren Buffett has famously said that if an investor was only allowed to make ten investing decision in their lifetime, he was confident the overwhelming number of them would make far better decisions and be successful. One could say that perhaps because investors now know the Fed can almost be bullied into making inter-meeting decisions, they create the conditions needed to force it.
If that ability was taken away, then would we see less volatility? I’m becoming convinced the huge volatility we have seen for the past decade and the increasing activity of the Fed during that time span not totally correlated. It is a chicken vs egg scenario. Is the Fed activity a reaction to events, OR, are the events a reaction to Fed activity? I am leaning towards the latter.
Why are we to believe that the Fed making an almost monthly interest rate decision is any better for the economy that if they were only allowed to do it quarterly? It would place far less emphasis on “today’s” news. It would also lengthen the myopic focus of the market of what the Fed will do next week.
This is especially true when most of the actions from the Fed have no real effect on the economy for many months down the road. This means the Fed is then making another decision without any actual evidence whether or not the first decision was the correct one. Actually, they then make SEVERAL more decisions without knowing if #1 was correct.
We then have the scenario where the investing public in mass starts speculating on the effect of all the current decisions on the economy will be. Again, all this happens with no empirical evidence of whether or not any of the decisions were correct or not. That leads to a mass mentality and the boom/bust cycles we seem to be jumping in and out of.
I’m not sure a commodity peg would solve the problem either, but I’m pretty sure no one can make “long term decisions” on a monthly basis without any quantifiable feedback…
I do think we need to make some changes though as the booms and busts differ, but Fed activism remains the same..