Are you celebrating yet? The United States came late to a party, and it has defined us ever since.
The party I mean is membership to that elite group of central bankers around the world. A hundred years ago tomorrow, our Federal Reserve was born. By that time, Britain had a central bank for more than two centuries. The United States resisted following their lead for a run of consecutive recessions until we realized we could no longer count on financiers to hold our economy together.
The motivation for a government-sanctioned monetary authority was the Great Panic of 1907. This was the last financial meltdown for which the nation trusted the private sector could sort out by itself. As the panic took hold, J. P. Morgan commanded his fellow bankers into his library and had his assistant lock the door from the outside. He then told his captive audience that the door would not be unlocked until everyone agreed to a strategy to return confidence in the nation’s financial markets.
Participants agreed to a strategy, to have their surrogates lend confidence by speaking to their church flocks the following Sunday, and they all agreed to meet at an offshore island to give the public a sense they were determined to forge a concerted plan to avert future monetary crises.
A growing nation discovered that its prosperity could ill-afford such solutions based on powerful personalities rather than effective policies. Six years later, the Federal Reserve System was created.
The Fed really did not have its head in the game for a couple more decades, though. They had drunk the Kool-aid and refused to intervene sufficiently in the Great Crash in 1929. While a central bank rarely throws a nation into a great recession, in both 1929 and 2008 they failed to intervene in a way that could ward one off.
In both circumstances, there were conflicting factors, to be sure. While there were plenty of signs of an impending financial crisis and the need for a broadbased stimulus, there were also signs of an overheated commodity sector and the possibility of inflation. These circumstances require conflicting monetary policy.
In both cases, the Fed acted like a deer in the headlights until it was way too late to prevent financial calamity. The Fed was on its heels in damage-control mode.
The problem with reactive monetary policy is that one cannot push a piece of string. The Fed is far more effective pulling an economy back down with tight monetary policy than pushing an economy back up with quantitative easing. And, if things go so far that market confidence is shattered, the Fed can do little but try to keep the lights on.
There is also the indoctrination problem. Economies are incredibly complex. A well-qualified and well-intentioned economic czar requires a set of skills that are a consequence of a combination of academic training and real-world market experience. It is only too easy, though, to become products of their own training.
They begin with a faith in free markets but end up becoming zealots. Those regulators that retain a healthy skepticism, like the recent FDIC chair Sheila Bair, or the past Commodity Futures Trading Commission chair Brooksley Born, are often attacked by the groups they are charged to regulate. The path of least resistance is a too-cozy relationship between the regulators and the regulatees. Directors change but the names seem to remain the same.
This revolving door between those too-big-to-fail and their regulators and back is just too incestuous by one half. We know what happens next. Combine this with a political system fueled by campaign donations, and one might wonder how markets are policed at all. And yet, we all suffer when greed at worst, or simplistic and reactionary policy at best, form the markets that affect the retirement and savings for us all.
There were other things than a reliance on financial markets that we could have done as a nation to avoid the worst of this Great Recession. We failed there too. The U.S. remained relatively hapless by trying policy to expand consumption and by bailing out states rather than by taking the more cohesive action of economic investment based stimulus.
Europe was equally divided as their nation-states argued and bickered. Meanwhile, Canada, Australia, and other economies managed well.
Colin Read chairs the finance and economics faculty at SUNY Plattsburgh and has published a dozen books on global finance and economics.